Bank of England: Interest rate hike predictions cool as trader sentiment resets
Fears of several interest rate hikes being made have eased as traders raved at the news of a ceasefire in the Middle East.
Markets are now pricing in just one interest rate hike as the two-year gilt yield dropped to 4.1 per cent.
The current interest rate is set at 3.75 per cent by the Bank of England.
The new pricing is a radical reset in investor sentiment compared to when, in mid-March, traders priced in three interest rate hikes.
This came as the Bank took a hawkish view on the war in its last monetary policy meeting given fears that the war in Iran could drag on for months.
The new ceasefire agreement between the US and Israel with Iran, mediated by Pakistan, has raised hopes that crude oil trade flows in the Gulf region will resume.
George Vessey, a macro strategist at the foreign exchange payments company, said the exposure of the UK economy to an energy price shock made interest rate expectations “especially sensitive to geopolitical developments”.
Goldman Sachs economist said Brits were likely to be “paying more attention” to price moves after having suffered from a spike in inflation after Russia’s full-scale invasion of Ukraine.
Bank governor Andrew Bailey said that traders were “getting ahead of themselves” in previously pricing in several rate hikes.
City divided on interest rates
While economists widely expect interest rates to be left on hold at the end of this month, some City analysts had opened the door to cuts being made later this year.
UBS Investment Bank chief European economist Reinhard Cluse said there could be a cut at the end of this year.
However, City economists remain largely divided as banks and industry officials attempt to make sense of the UK’s exposure to the economic impacts from the war.
IG market analyst Chris Beauchamp said any re-pricing to suggest that interest rate cuts were on the cards was unlikely to happen in the short term.
He added: “The most we can hope for right now is that the Bank stays on hold all year.”
MPC to consider second round effects
The Monetary Policy Committee’s next meeting will come on 30 April, after the deadline for the two-week ceasefire.
MPC members will be closely monitoring survey data over the coming weeks, particularly around people’s inflation expectations and job market trends.
Economists will be particularly worried about second round effects, where higher inflation can push up wage growth and vice-versa.
The OECD has warned that the UK economy was set to suffer the biggest hit from the energy price shock that has already led to fuel prices rising and supply shortages in developing countries.
It suggested that the UK would suffer the second highest level of inflation in the G7 and second lowest growth rate this year among the group of advanced economies.
An IMF blog post also warned that the UK economy was more exposed than other European countries by trade disruption across the Strait of Hormuz.