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UK Interest Rates Update

01 August 2018
2 Minute Read

With interest rates set to move higher for the second time in ten years – and to their highest level since the financial crisis at that – markets are currently pricing in a 90% chance of a hike on Thursday.

It was as recently as May that markets were last expecting interest rates to be raised, only for the Bank of England to change their tune in the weeks leading up to the decision. However, at this stage in the game it would be a shock to markets if interest rates did not increase to 0.75% later this week, making it difficult to imagine any significant moves in asset prices (bond, equity or sterling) in the direct aftermath of the announcement unless forward guidance is changed substantially.

Strong global growth

Ultimately, interest rate normalisation is long overdue, with the overall strength of the economy and its growth over the last five years suggesting that we could withstand higher interest rates despite inflationary pressure.

In hindsight, the UK has actually been quite fortunate with the timing of Brexit, in the sense that it has coincided with the strongest period of global growth since the financial crisis and a world that has been the most synchronised it has ever been from a globalisation perspective.

Going into 2016, the UK was one of the fastest growing economies in the developed world but is now a laggard amongst these nations. Nonetheless, it is widely believed that the level of growth we are currently experiencing is strong enough to withstand higher interest rates, and this appears to also be the view of the Bank of England.

While it is unlikely that the current economic cycle will see interest rates peak anywhere near the last highs we saw back in 2007 (5.75%), perhaps half that figure would be a more realistic expectation for markets.

A “win-win” decision

What is surprising however, is the timing of this interest rate decision given its proximity to Brexit negotiations.

There are two possible conclusions one can draw from this. Either the Bank of England feels increasingly confident that we will achieve a positive outcome from ongoing negotiations and growth will remain strong as a result. Or, the Bank is looking to inject some “firepower” into the economy if we do face a bad outcome and is giving itself the flexibility to stimulate the economy in the not-so distant future.

Famously, the Bank of England cut interest rates immediately after the referendum in August 2016 and restarted its quantitative easing programme in order to reduce the impact of the result on the economy.

Perhaps this move will put the Bank in a “win-win” position. If the Brexit result is positive they will have done the right thing, but equally, if growth stalls from a “no deal” result then they will still retain the ability to manoeuvre going forward.