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Higher interest rates beckon for the UK

Stronger-than-expected economic growth data fuelled expectations of an imminent increase in UK interest rates, creating some short-term volatility in gilt yields. Consumer price inflation reached 3% YoY, and the Bank of England subsequently raised base rate to 0.5% in early November.

  • The IMF issued a downbeat assessment of the UK’s economic outlook
  • Credit ratings agencies Fitch and S&P confirmed their “AA” credit ratings for the UK
  • The unemployment rate remained at a four-decade low of 4.3%

"Wage growth… remains subdued and is not keeping pace with inflation"

Stronger-than-expected economic growth data fuelled expectations of an imminent increase in UK interest rates, creating some short-term volatility in gilt yields. Over October as a whole, however, the ten-year gilt yield eased from 1.41% to 1.37% , but remained well above the level of 1.24% with which it began 2017. Meanwhile, the yield on the short-dated gilt – which matures in 2020 – ended the month unchanged at 0.54%.

Economic growth in the UK strengthened during the third quarter, growing at a quarterly rate of 0.4%, compared with a rate of 0.3% in both the first and second quarters. The annualised rate of consumer price inflation rose to 3% in September, reaching its highest level for over five years, driven up by higher import prices caused by sterling’s weakness. Central bank policymakers subsequently increased rates for the first time since July 2007 , raising them from 0.25% to 0.5%.

Although the International Monetary Fund (IMF) expects growth in most of the world’s advanced economies to strengthen over 2017 as a whole, it regards the UK as a “notable exception”. Productivity in the UK continued to decline during the second quarter of 2017; meanwhile, the EY ITEM Club believes the economy will continue to struggle for momentum during the final quarter of 2017 and into 2018.

During October, credit ratings agency Fitch maintained its credit rating for the UK at “AA”, but highlighted the risks posed by Brexit. In particular, Fitch cited the lack of a clear British position in the Brexit negotiations, the EU’s stance, and the limited amount of available time, warning that these factors would reduce the UK’s ability to secure a favourable agreement. Ratings agency Standard & Poor’s (S&P) also maintained its “AA” rating for the UK alongside a “negative” outlook.

The UK’s rate of unemployment remained at 4.3% during the three months to August, representing its lowest level since 1975. Wage growth, however, remains subdued and is not keeping pace with inflation. Average earnings (excluding bonuses) rose by 2.1% year on year in the three months to September, but fell by 0.4% in real terms. According to the EY ITEM Club , the tightening labour market does not appear to be generating higher pay, and UK companies are likely to remain cautious in the short term as the slow progress of Brexit negotiations curbs investment plans.

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