Markets still underestimating pace of rate hikes

Financial markets are now pricing in a 60% probability of the Monetary Policy Committee (MPC) raising Bank Rate by a further 25bps in May, up from around 40% at the start of the year. But we still think investors are underestimating the pace of tightening further ahead. The MPC is keen to normalise policy – returning interest rates to a level from which they can be substantially cut in response to a future downturn. If we are right in thinking that economic growth will outperform the Bank of England’s forecast, and pay pressures continue to build, the MPC will probably press ahead with rate hikes. We expect three increases this year and a further two in 2019, leaving Bank Rate at 1.75% by the end of that year. By contrast, only two hikes are fully priced into financial markets over the same period. As a result, and with the US Fed continuing to increase its policy rate, 10-year gilt yields should continue to rise, reaching 2% by end-2019, up from 1.6% now.