Traders’ Low Expectations for BOE Rate Stir Complacency Debate
(Bloomberg) -- Traders’ expectations for U.K. interest rates are hardly budging even after the Bank of England revealed its plan to unwind record monetary easing, spurring debate over whether markets are too complacent.
While money markets are betting the BOE will raise borrowing costs -- currently at a record-low 0.1% -- 15 basis points by June and another 25 basis points in the summer of 2023, there’s little priced beyond that and expectations are for the bank rate to be around 0.5% in five years.
For Bank of America, that makes sense. The BOE’s plan to start scaling back its bond-buying program when the bank rate rises to 0.5% would exert tightening pressure, according to U.K. chief economist Robert Wood.
Meanwhile, its emphasis on transitory inflation and forecast for prices to fall back to 1.89% in three years implies there may be little reason to raise borrowing costs beyond what markets expect, he added.
“The inflation forecast combined with the new quantitative tightening plans suggests a high hurdle to raising the Bank Rate above 0.5%,” Wood wrote in a note. “Putting it simplistically: the BOE says one or two rate hikes -- fine. The next ones, not so much.”
ING Groep NV senior rates strategist Antoine Bouvet says markets are too relaxed about the prospects for the BOE to reduce its gilt holdings and that could mean higher borrowing rates.
“The 0.5% terminal rate priced by the curve is too low, so at some point the market will realize that,” said Bouvet, who expects long-end U.K. yields to then rise more relative to their shorter peers.
The BOE said it expects growth to recover to its 2019 level by the end of this year, and raised its outlook for gross domestic product in 2022 and 2023.
For Pooja Kumra, rates strategist at Toronto Dominion, the labor market holds the answers. Almost 1.9 million people in the U.K. are still on furlough, which ends next month. Government spending to protect jobs and businesses through lockdowns has pushed Britain’s debt pile to 2.2 trillion pounds ($2.6 trillion), the highest as a percentage of economic output since the 1960s.
The state of the jobs market “will be the key driver for how quickly or slowly we can price the policy rate at 50 basis points,” Kumra said.
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