18th June 2014
Fund firm Schroders has changed its interest rate forecast following what it says are mixed messages to markets from the Bank of England.
In a note issued this week, Schroders European economist Azad Zangana says: “The minutes from the latest Bank of England (BoE) Monetary Policy Committee (MPC) meeting warn that there is a rising risk that interest rates may have to rise in 2014 – sooner than the financial markets were expecting. The meeting minutes revealed that early indicators of economic activity had been stronger than expected, and so the Bank’s central view that the economy may slow in the second half of the year may prove to be too pessimistic. Therefore, the minutes state that “In that context, the relatively low probability attached to a Bank Rate increase this year implied by some financial market prices was somewhat surprising.”
Bank of England Governor Mark Carney provided a preview of the change in tone to a more hawkish stance in his Mansion House speech, when he warned that the first rise in interest rates “…could happen sooner than markets currently expect.” says Zangana (pictured).
Yet Zangana says that that despite the change in tone on the outlook for interest rates, the assessment of the overall risks to the economy seem to be largely unchanged, and none of the MPC members voted for a rise at the last meeting.
He adds: “The external environment remains difficult, with the Eurozone struggling to boost growth and inflation, while the domestic economy is still not showing signs that spare capacity is being absorbed – highlighted by the falls wages when inflation is taken into account. The minutes also showed growing concern that the very recent easing in housing activity could prove to be more permanent that previously thought. The introduction of the Mortgage Market Review appears to have disrupted activity by complicating the application process for borrowers.”
The economist says therefore that the messages from the minutes were mixed and somewhat puzzling.
“Despite the Bank stating that forward guidance would be data dependent, very little new information is available, and even less than would prompt markets to expect higher interest rates sooner as suggested should have been the case by Carney. The minutes are packed full of reasons as to why policy should remain unchanged for quite some time, and yet, the Governor felt he needed to change his communication to move financial markets. The Bank of England has clearly had a communication problem since the introduction of data contingent forward guidance, and events over the past week have highlighted the issue further.”
“With regards to Schroders’ forecast for the first rise in interest rates, it appears that the Bank of England is preparing markets for that first increase to take place before the general election. We are therefore bringing forward our forecast for the first increase to February 2015, and expect 25 basis points of rises per quarter, taking the end of 2015 forecast to 1.50% – later and lower than priced in by markets. As the Bank continues to focus on the outlook for inflation, the latest fall to 1.5% in the CPI measure is likely to weigh on their outlook.”