Delaying a UK rate hike inflationary shock

The possibility of a delayed rate hike in the UK combined with a more active ECB could create an inflationary shock, says Kames head of fixed income David Roberts.

Delaying a UK rate hike inflationary shock


Roberts points out that the papers are currently full of the news that the currency is taking a bashing as polls show that the Scottish independence referendum is going to be close run thing.

“There is of course material danger in a weaker currency for the UK (with or without Scotland). Reducing investor confidence, rising volatility makes it more difficult to attract foreign capital irrespective of the potential benefits to exporters.”

But, he adds, “However, more important right now is the inflationary threat. UK inflation has fallen only marginally below MPC target when commodity prices were collapsing and Sterling was rising. Delaying a rate rise now as both Scottish and UK economies approach full capacity, as the ECB finally starts to act, inspiring a further weakening of the Pound could create an inflationary shock not seen since the 1970s.

In terms of the gilt market, Roberts says that pre independence nerves continue to impact government bond securities.

“The jury seems to be out as to whether Gilts benefit or not – trading political and economic uncertainty against a possibility of delayed rate hikes. The biggest impact so far has however been outside of the UK. For Spanish bonds there is no doubt the threat is bad. Traders fear a similar referendum in Catalonia could have devastating effects upon the Spanish economy and financial system – Spanish bonds, the darling of markets for most of 2014 are rapidly adopting pariah like status. Funding costs, although materially lower year to date, have risen from around 2% toward 2.3%, potentially adding Euro billions to the Spanish government’s debt servicing cost,” he adds.