Although the UK’s economic recovery has gone from strength to strength, markets have remained optimistic that monetary policy will remain highly accommodative for a while longer yet. Indeed, on the basis of its past relationship with measures of labour market slack, the Gilt market may be beginning to underestimate the degree of tightening required over the next few years. In addition, money markets are pricing in looser policy than the recovery in the business surveys suggest. Admittedly, there is still a large amount of spare capacity in the economy, and the outlook for inflation over the coming years remains subdued, which should allow the MPC to keep rates low. However, if the economic recovery maintains its current rapid momentum, markets are likely to keep looking at the MPC for reassurance that monetary policy tightening will be extremely gradual.
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