No pushback against higher gilt yields, but little prospect of rate hikes - Capital Economics
UK Economics

No pushback against higher gilt yields, but little prospect of rate hikes

UK Economics Update
Written by Ruth Gregory
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The Monetary Policy Committee did not follow in the ECB’s footsteps by stepping up the pace of its QE purchases. Instead, it echoed the message of the Fed by emphasising that rate hikes are still a long way away. This suggests that rates won’t rise next year as the markets expect. In fact, we think that rates could stay at +0.10% until 2026!

  • The Monetary Policy Committee (MPC) did not follow in the ECB’s footsteps by stepping up the pace of its QE purchases. Instead, it echoed the message of the Fed by emphasising that rate hikes are still a long way away. This suggests that rates won’t rise next year as the markets expect. In fact, we think that rates could stay at +0.10% until 2026! (See Chart 1.)
  • Alongside the unanimous vote to leave Bank Rate at +0.10% and the stock of QE at £895bn, the Committee maintained its commitment to complete the £150bn of extra QE launched in November by “around the end of 2021”. That’s consistent with the pace of QE being slowed at some point from the current £4.4bn a week and implies that the Bank is not too concerned by the recent rise in gilt yields. Indeed, the Committee judged that the rise had been triggered by improved fundamentals including the “positive news on global economic growth…vaccination programmes and vaccine effectiveness, as well as the size of the US fiscal support package”, rather than illiquidity or a jump in inflation expectations.
  • The MPC appeared a bit more upbeat about the economic outlook. While the Fed yesterday did not even acknowledge the boost the improving virus situation and vaccine rollout had given to the economic outlook, the MPC at least commented that the news on the near-term economic outlook has been positive. Indeed, it stated that the government’s lockdown easing roadmap was faster than the Bank had assumed and was consistent with a “slightly stronger outlook for consumption growth in 2021 Q2”. And that the Budget had provided extra near-term support to the economy. It judged that the extension of the furlough scheme from the end of April to the end of September meant the unemployment rate would peak below the 7.8% rate it predicted in February.
  • But the minutes otherwise struck a generally cautious tone. The Committee does not seem convinced that the medium-term economic outlook had brightened much. It inserted a new line into the policy statement that it judges that there is a “material degree of spare capacity at present”. And while CPI inflation is still expected to rise sharply to the 2% target in the spring, the minutes stated that this rise “should have few direct implications for inflation over the medium term”. The MPC did not change its guidance that downside risks remain either and that policy should continue to lean strongly against these risks.
  • Crucially for the policy outlook, while the MPC stopped short of explicitly saying that the markets had got ahead of themselves in expecting rate hikes from mid-2022, it once again stated that it won’t tighten policy until it is “achieving the 2% inflation target sustainably.” That means it’s not enough for the Bank to forecast inflation rising and staying above 2%, it needs to see that actually happen.
  • Our inflation forecast suggests the Bank probably won’t contemplate reversing QE or raising interest rates until 2023/24. (See Chart 2.) And even then, the Chancellor may be fretting about the effects of higher interest rates on the public finances and may come up with ways to convince the Bank to keep rates lower for longer.
  • Overall, we think the markets have gone too far in expecting interest rate hikes from mid-2022. We think that rates won’t rise above their current rate of +0.10% until 2026. As a result, we doubt the 10-year gilt yield will increase much above 1.00% over the next two years.

Chart 1: Bank Rate Expectations (%)

Chart 2: CPI Inflation (%)

Sources: Refinitiv, Capital Economics

Sources: Bank of England, Capital Economics


Ruth Gregory, Senior UK Economist, +44 (0)7747 466 451, ruth.gregory@capitaleconomics.com