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Base rates are rising again, albeit slowly, as the Bank of England seeks to control inflation – but Brexit uncertainty may yet force a change in its plans
As expected by the market, the Bank of England’s Monetary Policy Committee (MPC) finally raised interest rates on November 2nd, from 0.25% to 0.5%. It also released revised economic forecasts, predicting the economy will now grow only by 1.6% next year and by 1.7% in 2019, a downgrading of
Following these announcements, sterling fell against the dollar and the euro, while 2-year swaps rates were trading below 80bps, having been close to 90bps 24 hours earlier. The first rate rise in more than ten years also caused great excitement in the media, even though rates only returned to the level where they had been between 2009 and mid-2016, when the Bank cut them in the aftermath of the EU Referendum. This could be a turning point – but Brexit may yet exercise a strong influence over MPC decisions again during the months and years ahead.
The Bank’s primary aim is to push inflation back down, from 3% towards its 2% sustainable target. Mark Carney said there were some indications that wages were beginning to rise and that the squeeze on household incomes was loosening. MPC members may also have been influenced by the Bank’s figures on consumer debt, released in late October, which had reached an annual growth rate of 9.9%.
But Mr Carney sought to play down the suggestion that this increase could herald the start of a swift escalation of interest rates. He said the Bank’s economic forecasts suggested the need to raise interest rates by a quarter of a per cent twice more during the next three years, reaching 1% in 2020.
The Bank expects economic conditions to apply downward pressure to inflation during 2018, reducing the need to raise interest rates more quickly at that point. However, it has also noted that its forecasts are predicated on a stable transition to a new trading relationship with the EU, so future setbacks in the Brexit negotiations may yet prompt a review of its strategy, and they will likely be the biggest factors for the next rate hike, either up or down.
Market expects the Bank to raise the Base Rate to 0.75% by the end of 2018 and to reach 1% in 2020 (see table, below). We expect three month LIBOR to follow a similar trend. Market anticipates 2-year swap rates moving up from 0.75% to 1% in 12 months’ time, then to 1.25% in 2020. 3-year and 5-year swaps should move from 1% to 1.25% from 2019; while 10-year rates move up from 1.25% to 1.5% within the same period.