A rate rise in the UK has suddenly become a possibility. There is still much to fear on the outlook for the UK – is Carney really likely to blink?
- The conditions for a rate rise do not appear auspicious – a credit downgrade and weakening growth
- But there is pressure from pension funds and from rising consumer debt
- A rise may not be as likely as markets currently believe
Surely the UK can’t raise rates? It has just been downgraded by Moody’s, the consumer is under pressure, GDP growth is stalling, and then there’s all that Brexit business, which doesn’t seem to be going all that well. However, the Bank of England appears to think differently.
The recent Bank of England minutes and subsequent comments by Governor Mark Carney, took a far more hawkish tone. An interest rate rise was not just possible, but probable, they suggested, given the rising consumer debt burden.
Markets took notice. Government bond and currency markets both reacted sharply to the move. The market is now expecting a rise in the UK base rate of 25bps between now and the year end. This marks a significant shift from just a few weeks previously, when the market wasn’t expecting a rise until 2019.
A subtle, but additional pressure is coming from rising pension fund deficits. The most recent figures from the Pension Protection Fund (PPF) 7800 Index showed the aggregate deficit at £220bn, a rise of £40.3bn compared to the previous month. If the gilt yield were to rise, it would give pension funds some breathing space and there may be increasing pressure on Carney to address the problem.
Equally, the downgrading of the UK’s credit rating may be a red herring. It simply brings Moody’s in line with other rating agencies and appears a little after-the-event. After all, citing Brexit concerns 18m after it happened seems at best, ‘slow burn’. The UK’s sovereign rating has historically been of little concern to markets and this time was no exception - it hasn’t influenced the gilt yield or sterling.
However, while the Bank of England could raise rates, it is not perhaps as certain as markets are suggesting. The currency has risen, which diminishes inflationary pressure (perhaps Carney’s intention). Equally, Carney was clear that a number of economic criteria needed to be fulfilled. There needs to be improving economic data and some clarity on the Brexit negotiations.
Also, while pension funds might be keen for the gilt yield to rise, it is unlikely a rise in rates would help them as much as they think. There is considerable latent demand for gilts and this is likely to keep yields low for the foreseeable future.
While interest rates could rise, it is perhaps not as likely as markets are suggesting. Carney must tread a fine line.