Kicking the can down the road on British rates – again

January 28, 2016

Bank of England Governor Mark Carney speaks during the bank's quarterly inflation report news conference at the Bank of England in London August 13, 2014. The Bank of England forecast on Wednesday that wages would grow far more slowly than previously expected and linked their rate of increase closely to borrowing costs, suggesting it was in no hurry to raise Britain's record low interest rates.  REUTERS/Suzanne Plunkett   (BRITAIN - Tags: BUSINESS POLITICS) - RTR4299J

Forecasts for when the Bank of England will raise rates have been put off into the future for the seventh time since Mark Carney became Bank of England Governor nearly three years ago.

The U.S. Federal Reserve, once thought likely to trail the BoE, made a hesitant start last month.

Now there’s a growing minority of forecasters agreeing with traders in financial markets that it might be closer to the end of the decade before UK rates rise above their record low of 0.50 percent, where they have been pinned down since 2009.

That means that the pound, which is down about 4-1/2 percent this year already, will remain under pressure. It will also keep mortgage rates very cheap.

The trouble is, inflation has been stuck at or below 0.3 percent over the past year, well below the BoE’s 2 percent target. And the latest GDP data for the fourth quarter of last year showed the trend of relatively modest economic growth – at least not enough to generate a resurgence in domestically-generated inflation, is well-entrenched.

And Chancellor of the Exchequer George Osborne’s fiscal stance remains austere, not expansionary.

Perhaps more importantly right now, not just for the BoE, but also for the U.S. Federal Reserve, financial markets have had a terrible start to the year.

That has already cast doubts over further Fed rate hikes this year and how soon the next one will come.

Plunging inflation expectations and unsettled markets have also prompted calls for more easing by the BoE’s continental peer, the European Central Bank.

To be sure, markets nearly always overshoot, and even more so since they’ve been awash with trillions of dollars of central bank cash.

But the gap between short sterling not taking into account a rate move until early 2018, and the newest economist consensus for November this year, is the widest it’s ever been.

On the face of it, all of that suggests nobody really knows what will happen, not least Governor Carney.

Two-year Gilt yields – sensitive to the future direction of UK rates – have fallen over 20 basis points so far this year. At 0.40 percent, they’re 10 basis points below Bank Rate and the lowest since April, about when economists had started to move their calls for a rate hike to early 2016 from a previous prediction of late 2015.

No fixed-income strategist predicted that fall in a Reuters poll taken last month.

Now nine of 59 economists surveyed this week said no there will be no UK rate hike this year, compared with just one of 54 surveyed two weeks ago.

If rattled markets and a shaky global economic backdrop weren’t enough, Britain will soon be going to the polls to decide whether it stays or leaves the European Union. That raises additional uncertainty until the question is posed and answered.

James Knightley, senior economist at ING Financial Markets noted:

Irrespective of the outcome, the uncertainty that the vote will generate is likely to see a loss of momentum in the UK economy – possibly knocking around a quarter of a percent off 2016 growth.

Both UK and foreign businesses are likely to take a ‘wait and see’ approach to hiring and investment while consumer spending and confidence could weaken modestly. 

All of this points to one likely outcome – UK rates staying low for longer.

— With reporting by Krishna Eluri and Deepti Govind

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