Investor bets on where UK interest rates will peak have risen sharply over the past month, sparking an attempt by Bank of England governor Andrew Bailey to stop the market craze.
Futures markets are now quoting the BoE’s interest rate hike to just above 4.6% by December. Rates were expected to peak at around the current 4 percent in early February and fall slightly towards the end of the year as investors fear the UK is heading into a recession.
This is despite more mixed UK economic data in recent weeks. While headline inflation remains in double digits, domestic core inflation, which excludes food and energy price volatility, eased more-than-expected to 5.8 percent in January from 6.3 percent the previous month. In contrast, business surveys for February showed a faster-than-expected increase in activity.
This week, Bailey countered the rapid change in expectations, arguing that the central bank has “moved away” from the “presumption” of the need for further rate hikes. His comments led to a slight decline in interest rate expectations, but traders are nevertheless betting that the Bank of England has become much more aggressive than a month ago.
Some analysts say markets are overdoing it with bets that UK rates will rise sharply after US rates.
“The general consensus is that the Bank of England will pretty much copy the US Federal Reserve in the next few months,” said Samuel Tombs, chief economist at Pantheon Economics in the UK. However, in the past it has often been a mistake to assume that [BoE] will follow the Fed.”
The February recovery in interest rate expectations in the UK came after a blockbuster US jobs report in early February, which shattered the impression of a slowdown in economic activity and hopes for an early end to the Fed’s aggressive monetary tightening campaign. Traders spent the next month building up their expectations of where US rates could peak.
Bailey’s comments “looked positively dovish,” analysts at Rabobank said, and contrasted sharply with those of bank officials in England in Europe and the US, where headline inflation is lower but appears to be tighter than previously forecast.
According to Tombs, there is reason to expect the Bank of England to stop raising rates soon, before the Fed “remains strong.” Rate changes have a “proportionately larger” impact on UK activity than in the US as most UK corporate bank loans are floating rather than fixed rate and “nearly all” UK mortgages must be refinanced within five years.
These and other differences explain why the Fed warned last month that a “permanent rise” would be needed to bring inflation down, while the Bank of England suggested that UK rates may have peaked.
Bailey’s comments this week “make clear” that the central bank’s monetary policy committee is “giving more attention to the substantial tightening already in place,” Tombs said, though he hasn’t completely ruled out a further quarter-point rate hike later this year. . . .
“In the US, Fed officials rarely make the markets doubt their next policy decision,” Tombs said. “But MPC has a penchant for drama.”