Our views

Gilt corner: seven reasons why the Bank of England might NOT raise interest rates this week


Paul Rayner, Head of Government Bonds

30 October 2017

This week sees the most important monetary policy event of the year, with the Bank of England (BoE) widely expected to reverse last year’s cut to interest rates. The UK gilt market sold off sharply when the news was first announced and according to Bloomberg’s WIRP (a key measure of interest rate predictions), there is an 88.6% chance of a rate hike, just down from a peak of over 90% this week.
Despite this, a few dovish tones have started to creep into policy maker rhetoric, and coming into the vote we’ve been reducing the level of risk in our funds, cutting our short duration in half, down to just 0.25 of a year.
While our base case still backs the consensus view for a November rate hike, it would be remiss of us to not assess the contrarian arguments. With that in mind, here are seven reasons why the Bank of England might not actually hike interest rates on Thursday:
- The Bank continues to see the uncertainty surrounding Brexit. As negotiations rumble on in Brussels, the aftermath of the referendum and its impact on the economy are still seen by the Bank as a key risk, and a reason to maintain emergency stimulus measures. In our view Mark Carney is not the ‘enemy of Brexit’ which Jacob Rees-Mogg labelled him, but he does have a duty (and independence from government) to keep the UK economy’s stability on track.
- GDP doesn’t tell the whole story about the UK economy. Policy makers may have been slightly assuaged by a rosier than expected GDP number which saw a sell-off in gilts on Wednesday last week, that has since rallied back. Despite this uptick in growth, UK economic growth is still trailing in the G20 rankings and a number of domestically focused firms have recently issued profit warnings, citing tougher trading environments in months and years to come.
- Consumer credit conundrums. The decline in gilt yields was partly down to retail sales data published last Thursday which highlights growing concern, expressed from many fronts, about the resilience of the UK domestic economy. Fuelled by worries over the accessibility and scale of cheap consumer credit, the Bank of England has already told lenders to raise capital buffers, and may not want to heap further pain on consumers by increasing interest costs.
- Earnings growth looks low on more than one measure. This reliance on borrowing in the domestic economy is underscored by a trend of negative real earnings. While this might usually be seen as an opportunity to raise rates to combat the inflationary impact which has led to this, underlying earnings growth is still very low by historical standards, and well below where it sat when the Bank last raised rates.
- The bank’s inflation fears might have receded. On the flipside, with the November base rate decision comes the quarterly inflation report. Should the Bank’s inflation expectations trend lower, they might see it as prudent not to hike interest rates at a possible inflationary peak. Sterling has been gradually appreciating over the past year, which should slow the rate of price increases accordingly.
- It only takes one policy maker to tip things the other way. Whatever the outcome on Thursday, investors can be pretty certain that not all 9 Monetary Policy Committee members votes will line up nice and neatly. With the current market consensus for the outcome of the vote a 6-3 or even 5-4 split in favour of hiking, it wouldn’t take too many doves to pitch things the other way.
- It might be on the way, but just not yet. Investors and traders have focused on a November hike. Although a 0.25% increase is probably the easiest way for the Bank to withdraw monetary stimulus, the market has set out its stall on comments such as ‘some withdrawal of monetary stimulus is likely to be appropriate over the coming months,’ and a comment by Mark Carney that interest rates are likely to rise ‘in the relatively near term’. What’s to say that the Bank doesn’t hold things back till the meeting in February, at which point some of their other worries might have receded. 

This week sees the most important monetary policy event of the year, with the Bank of England (BoE) widely expected to reverse last year’s cut to interest rates. The UK gilt market sold off sharply when the news was first announced and according to Bloomberg’s WIRP (a key measure of interest rate predictions), there is an 88.6% chance of a rate hike, just down from a peak of over 90% this week.

Despite this, a few dovish tones have started to creep into policy maker rhetoric, and coming into the vote we’ve been reducing the level of risk in our funds, cutting our short duration in half, down to just 0.25 of a year.

While our base case still backs the consensus view for a November rate hike, it would be remiss of us to not assess the contrarian arguments. With that in mind, here are seven reasons why the Bank of England might not actually hike interest rates on Thursday:

- The Bank continues to see the uncertainty surrounding Brexit. As negotiations rumble on in Brussels, the aftermath of the referendum and its impact on the economy are still seen by the Bank as a key risk, and a reason to maintain emergency stimulus measures. In our view Mark Carney is not the ‘enemy of Brexit’ which Jacob Rees-Mogg labelled him, but he does have a duty (and independence from government) to keep the UK economy’s stability on track.

- GDP doesn’t tell the whole story about the UK economy. Policy makers may have been slightly assuaged by a rosier than expected GDP number which saw a sell-off in gilts on Wednesday last week, that has since rallied back. Despite this uptick in growth, UK economic growth is still trailing in the G20 rankings and a number of domestically focused firms have recently issued profit warnings, citing tougher trading environments in months and years to come.

- Consumer credit conundrums. The decline in gilt yields was partly down to retail sales data published last Thursday which highlights growing concern, expressed from many fronts, about the resilience of the UK domestic economy. Fuelled by worries over the accessibility and scale of cheap consumer credit, the Bank of England has already told lenders to raise capital buffers, and may not want to heap further pain on consumers by increasing interest costs.

- Earnings growth looks low on more than one measure. This reliance on borrowing in the domestic economy is underscored by a trend of negative real earnings. While this might usually be seen as an opportunity to raise rates to combat the inflationary impact which has led to this, underlying earnings growth is still very low by historical standards, and well below where it sat when the Bank last raised rates.

- The bank’s inflation fears might have receded. On the flipside, with the November base rate decision comes the quarterly inflation report. Should the Bank’s inflation expectations trend lower, they might see it as prudent not to hike interest rates at a possible inflationary peak. Sterling has been gradually appreciating over the past year, which should slow the rate of price increases accordingly.

- It only takes one policy maker to tip things the other way. Whatever the outcome on Thursday, investors can be pretty certain that not all 9 Monetary Policy Committee members votes will line up nice and neatly. With the current market consensus for the outcome of the vote a 6-3 or even 5-4 split in favour of hiking, it wouldn’t take too many doves to pitch things the other way.

- It might be on the way, but just not yet. Investors and traders have focused on a November hike. Although a 0.25% increase is probably the easiest way for the Bank to withdraw monetary stimulus, the market has set out its stall on comments such as ‘some withdrawal of monetary stimulus is likely to be appropriate over the coming months,’ and a comment by Mark Carney that interest rates are likely to rise ‘in the relatively near term’. What’s to say that the Bank doesn’t hold things back till the meeting in February, at which point some of their other worries might have receded. 

Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.