MPC unlikely to wait as long as markets think

Financial markets still do not expect interest rates to rise until the end of 2016. While we agree that interest rates will rise very slowly, we expect the first rise to come sooner, probably in the middle of next year. After all, the MPC’s Inflation Report showed inflation projected to be above target at the policy horizon on the basis of the markets’ benign rate view. The fact that a December rate rise in the US is on the cards might also at the margin prompt UK rates to rise sooner rather than later. While there are good reasons for rates to raise later in the UK than in the US, the MPC may feel more comfortable following suit if US rates rise without a big adverse impact on confidence or financial markets. So we still think that 10-year gilt yields will pick up from about 2% at present to 2.5% by the end of next year. That said, we think that markets are underestimating the speed with which US rates will rise by more than in the UK and so we still expect some softening in sterling next year.