Markets right to expect slow monetary tightening

The prevailing view in the markets that the MPC can raise interest rates extremely gradually over the coming years seems right to us. Granted, wage growth has begun to pick up and the Fed looks set to start raising interest rates from September. But we continue to think that there is considerable scope for UK productivity to recover, keeping a lid on domestic price pressures. And the MPC need not fear a weaker exchange rate if it does not hike interest rates as soon and as quickly as the Fed – indeed, it would probably welcome the support to inflation that a weaker pound would provide, as well as the boost to the competitiveness of the UK’s exports. Accordingly, we think that Bank Rate will remain on hold until the second quarter of next year and could still be as low as 1.5% by the end of 2017. This should ensure that gilt yields rise at a fairly gradual pace by past standards and equity prices have scope to rise further.