A rate cut always looked unlikely, but the devil will be the detail as the Bank of England shows its working.
- The 10 year gilt yield has dropped since the start of May, from 4.37% to its current level of 4.13%.
- The US 10 year bond yield has only fallen 4.1%, while gilts have dropped 5.5%
- At the moment, markets are forecasting around two cuts of 0.25% in 2024, with the first cut likely to be in August
No-one expected the Bank of England to raise rates this month. The last set of inflation figures shows ongoing pressure, wages are still rising, and there are tentative signs of improvement in the UK economy, which may make inflation harder to quell. However, there are increasing signs that the market expects the UK to diverge from the US on rates policy sooner rather than later.
Government bond markets have been extremely volatile, as rate expectations have bounced around with each fresh data point. However, having climbed steadily since the start of the year, the UK 10 year government bond yield has started to drop since the start of May, from 4.37% to its current level of 4.13%.
Admittedly, this is partly because the US jobs figures have given greater hope of a US interest rate rise. However, the US 10 year bond yield has only fallen 4.1%, while gilts have dropped 5.5%. The pound has also dropped against the Dollar as traders have started to bet that the Bank of England will move first.
At the moment, markets are forecasting around two cuts of 0.25% in 2024, with the first cut likely to be in August and a second one in December. Gilt yields are likely to remain sensitive to any data that interferes with this assumption, rising if inflationary pressures re-emerge, or falling if economic data proves weaker than expected
Markets will be analysing the Bank of England’s accompanying statements in forensic detail. While Governor Andrew Bailey has been guarded on rate cuts, he has expressed confidence that rate cuts will materialise in the year ahead. While he is unlikely to be explicit on timing, he may emphasise that he can cut rates while maintaining relatively restrictive monetary policy or revise inflation lower.
It may be possible for the Bank of England to engineer some monetary stimulus, without actually cutting rates. If Governor Bailey makes the right signals, it may depress bond yields and create a defaqto rate cut.
Fund managers and economists are expecting headline inflation to drop significantly in the next few months as the fall in the Ofgem price cap feeds through into the data. Many still see value in the gilt market, believing yields are too high and likely to drop in the next few months. There are concerns that if the Bank of England does not handle expectations correctly, the fragile UK economy could slide into trouble.
