The Bank of England has had to navigate a difficult set of circumstances in its attempts to raise interest rates. As far back as 2014, Governor Mark Carney suggested that rate rises could come “sooner than markets currently expect,” only for those aspirations to be dashed. Indeed, the next move in interest rates turned out to be a rate cut, in the aftermath of the June 2016 Brexit vote. Then, after a carefully choreographed set of speeches indicating the time had finally come, interest rates were raised in November last year, with indications of more to come. The message was that the economy had sufficiently healed, as witnessed by the limited room for further falls in the unemployment rate and expectations of gently rising domestic capacity constraints – and, as a consequence, gently rising interest rates. The next rise in rates was anticipated to take place at the 10 May 2018 meeting of the Monetary Policy Committee.
Changing data, changing expectations
However, lower-than-expected UK CPI data and a weather-related slowdown in economic activity in March has called this into question, not least following Governor Carney’s latest interview, noting the weak data and that they have many meetings ahead to assess the economy.
Markets have reacted accordingly, reducing to around 50% the chance of a May policy rate hike and anticipating a cumulative hiking cycle of just 50 basis points (bps) from here. This all raises the question: Are we in for a repeat of 2014, when aspirations for hike rates get dashed by the data?
Our view is that this is a temporary slowdown in growth, in part weather-related but also due to tight consumer finances and a business sector held back by Brexit uncertainty. Over time we expect both wage growth and business investment to improve somewhat, as the Brexit negotiations proceed amicably.
Indeed, there is even the scope for fiscal policy to relent from a multi-year period of austerity. As such we still see scope for the MPC to hold the line and hike rates one to two times in 2018 and in 2019. Clearly risks remain, not least from the late-cycle dynamics we have noted in the global economy.
Given this backdrop, we see UK sovereign yields as rich relative to international peers, and continue to believe that investors will be best served by sourcing duration outside of the UK. We also see some scope for a modest appreciation in the British pound, not least due to our expectations of a non-disruptive Brexit.
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