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Central bank hawks start to circle

June 2017

Gilt yields rose strongly during June amid mounting speculation that the Bank of England might tighten monetary policy. Three members of the Monetary Policy Committee voted in favour raising the base rate, but officials remain concerned about the effect of higher borrowing costs on economic growth.

  • Gilt yields surged in June
  • Inflation rose to its highest level for almost four years
  • Wage growth is not keeping pace with the rising cost of living

Gilt yields rose strongly during June amid mounting speculation that the Bank of England (BoE) might tighten monetary policy. Over June as a whole, the ten-year gilt yield rose from 1.13% to 1.33% , while the yield on the short-dated gilt rose from 0.13% to 0.37% . The pound rallied above US$1.30 against the US dollar during the month, boosted by the possibility of higher interest rates.

“Gilt yields rose… amid mounting speculation that the BoE might tighten monetary policy”

BoE Governor Mark Carney emphasised during June that he does not intend to tighten monetary policy until he can properly assess the UK’s reaction to the prospect of “tighter financial conditions and the reality of Brexit negotiations”. Nevertheless, speculation over the possibility of higher rates was stoked by the news that, although BoE policymakers left interest rates unchanged at 0.25% at their June monetary policy meeting, three members of the eight-strong Monetary Policy Committee (MPC) voted to tighten rates. Despite mounting expectations that inflation will breach 3% later this year, BoE officials generally remain reluctant to tighten rates amid fears that higher borrowing costs could put a brake on economic expansion.

Some UK corporate bonds and commercial real estate assets might be overvalued, according to the BoE’s Financial Policy Committee (FPC) , because investors have not taken into account the downside risks to economic growth that are keeping interest rates at their current exceptionally low levels.

Consumer price inflation (CPI) rose from 2.7% in April to an annualised rate of 2.9% during May , reaching its highest level for almost four years. In comparison, average wages fell by 0.6% year on year, stoking fears that rising prices could choke consumer demand. The British Retail Consortium (BRC) reported a 0.4% annualised decline in sales during May; meanwhile BoE Governor Mark Carney warned that Brexit is likely to put pressure on UK households as the weak pound continues to push up prices.

Activity in the UK’s industrial sector was sluggish during April: output rose at a monthly rate of only 0.2%, and fell by 1.2% between February and April, curbed by a slowdown in energy and manufacturing.

Although the Conservative Party lost its Parliamentary majority in June’s snap General Election, Chancellor of the Exchequer Philip Hammond stated that he intends to adhere to his target of balancing the budget by the middle of the next decade, and the Government does not intend to increase taxes.

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