Receive free UK interest rates updates
We’ll send you a myFT Daily Digest email rounding up the latest UK interest rates news every morning.
Investors are now betting that UK interest rates will climb as high as 6.25 per cent — the highest level since 1998 — by early next year after the Bank of England this week stepped up its battle with inflation.
The BoE on Thursday lifted its benchmark borrowing rate by 0.5 percentage points to 5 per cent — more than the quarter point rate increase anticipated by the majority of market participants — following figures earlier in the week showing inflation remained stuck at 8.7 per cent in May, far above the central bank’s 2 per cent target.
The unexpectedly forceful response has convinced investors that the BoE is likely to continue raising rates aggressively until there is a decisive shift lower in consumer price rises, analysts said. Swaps markets now imply an interest rate of 6.25 per cent in February. As recently as last month, rates were expected to peak at less than 5 per cent.
“It will be difficult for the Bank to slow down without a significant drop in inflation, or a significant drop in the labour market, and neither is likely to come down very soon,” said Peter Schaffrik, economist at RBC Capital Markets. “I can see where the market is coming from, there is a risk that they keep going in [half percentage point] increments,” he said.
Jordan Rochester, a senior G10 FX strategist at Nomura, added that the Bank of England is now acting “much more like the Fed, and making interest rate decisions based on whatever the latest inflation data says and no longer relying on its forecasts.”
Friday’s moves came after BoE governor Andrew Bailey on Thursday declined to push back on previous market pricing that interest rates will peak at about 6 per cent, saying that the central bank was willing to do “what is necessary” to bring inflation down.
Short-term UK government bonds, which are highly sensitive to rate expectations, sank. The two-year gilt yield climbed 0.1 percentage points to 5.18 per cent, the highest since 2008.
The rising rates expectations place additional strain on UK mortgages, which are priced based on movements in the swaps market. UK mortgages have already been dubbed a “time bomb”.
The market’s expectation for higher rates has not come with a strengthening of sterling, a sign that investors are focusing on the damaging effects that higher borrowing costs will have on the economy.
The pound fell 0.4 per cent against the dollar on Friday to $1.2695, extending Thursday’s decline.
Further sterling weakness, which drives up the cost of imported goods, could be a problem for the BoE in its struggle to curb inflation.
Rochester said the slide in sterling following the rate announcement was “the market’s way of saying there’s a high chance of a car crash tomorrow”.
Read the full article here
