Rebound in growth to lead to higher interest rates

The bout of softer-than-expected inflation and activity data which caused the MPC to step back from hiking Bank Rate in May is certainly reason for caution. But like the MPC, we think that temporary factors were behind the slowdown, and suspect that growth will bounce back in Q2. Unsurprisingly, given annual regular wage growth was already above the MPCs full year forecast in Q1, the more hawkish members of the Committee are mindful of falling behind the curve. If we are right in thinking that growth will surprise on the upside over the rest of the year, interest rates would surely rise by more than the very modest tightening – of just one hike this year and next – that is currently priced into financial markets. Indeed, we expect two hikes this year, and a further two in 2019, taking Bank Rate to 1.5%. Alongside the continued rise in US Treasury yields, we think that this would push the 10-year gilt yield up to 2%, and the pound to $1.55 and €1.19 by the end of next year, up from $1.35 and €1.14 today.