Markets jolted by MPC’s new tone

The MPC’s recent hawkish comments have helped to push near-term interest rate expectations higher and have fuelled a further rally in sterling to its strongest trade-weighted level since October 2008. Ironically, sterling’s rise has perhaps given the MPC more scope to leave interest rates on hold, since a substantial undershoot of inflation below the 2% target now looks likely. Even so, the MPC seems confident that the recovery is secure and that Bank Rate should therefore not remain at ‘emergency’ levels for much longer. As a result, interest rates now seem most likely to rise in Q1 2015 and even a hike in 2014 cannot be ruled out. Nonetheless, we still think that markets are overlooking the extent to which low inflation will persuade the MPC to raise interest rates very gradually thereafter.