Following Mark Carney’s speech on 16 June, in which the Bank of England governor stated that “the decision as to when to start such a process of adjustment will likely come into sharper relief around the turn of this year”, the market is bracing for a UK interest rate rise to begin in 2015.
Considering that the policy was widely-anticipated to be implemented in mid-2016, Bell, F&C’s chief economist, believes that while the first hike in November would be a positive, the BoE should be looking to bring it as far forward as August.
“The time is right to raise rates, and the Bank of England should raise rates in August,” he said. “It is positive that it is coming sooner than anticipated, but it should be even sooner than that.
“The economy looks a lot stronger now, and there will be at least two or three votes in the MPC for a rate hike in August.
Bell explained that while some may question the effectiveness of an interest rate hike considering the UK inflation, currently at 0%, the data coming out of the economy is edging the BoE towards making a decision.
“The international environment has been extremely conducive to rate expectations being dramatically reduced,” he said. “In terms of rate rises being priced out of the market, the UK has had one of the biggest rallies of anybody.
“We ask ‘why raise rates when inflation is at record lows?’, and the answer is because wages are going up faster than productivity. The economy looks a lot stronger now, and there will be at least two or three votes in the monetary policy committee for a rate hike in August.”
Market impact
“Sterling will go up, and volatility will go up a lot,” Bell predicted. “When a rate rise is a long way off each piece of economic data changes the outlook, and when it comes to working out when to actually pull the trigger it becomes much more sensitive.”
However, Iain Stealey, co-manager of the JPM Global Bond Opportunities Fund, believes that the most compelling aspect of Carney’s speech was around the terminal base rate, which he says could have interesting implications at the long end of the yield curve.
It is very interesting that Carney thinks the terminal rate will end up pretty low,” he expanded. “The average base rate historically has been 4.5%, and Carney sees this rise ending at around half of that, which is lower than most people were expecting.
“If the base rate is going to be 2.25%, given that there is a very flat curve in bond markets and two, five, 10 and 30-year gilts are all yielding the same, if not slightly inverted. People have been saying for a while that there is no value in the gilt market, but a low base rate means that a 30-year gilt today at 278 basis points could be argued as having a bit of value, and there could be a bit of opportunity.
Guy Foster, head of research at Brewin Dolphin, believes that a peak interest rate of 2.25% could not just benefit the gilt space but also positively affect other areas of the market.
“At that level the gilt market would like pretty much fair value, and by implication we might have less concern over the valuations of other asset classes too,” he said. “Of course, Carney could be wrong, as he has been on lift-off date, but the hawkish portrayal of his words seems grievously misplaced.
However, Foser added that – in addition to wage pick-up continuing without being offset by productivity and non-wage costs being maintained – there are certain economic figures that need to be exhibited in order to hit the intended target.
“Growth needs to maintain a sustained pace of 0.6% per annum,” he expanded. “That equates to an annual pace of 2.4% and, over the next four quarters, the consensus expectation is for growth of 2.5-2.6% before dropping to 2.3% in Q3 2016.”
