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AJ Bell: Are we getting an interest rate rise for Christmas?

  • Andrew Bailey talks up an interest rate hike
  • Markets are now pricing in an 85% chance of a UK rate hike by Christmas
  • Around 10 million Britons haven’t seen interest rates above 1% in their adult lives
  • The impact of rising interest rates on funds, markets and investors

 

Laith Khalaf, head of investment analysis at AJ Bell, says:

“The market is now expecting an interest rate hike by Christmas, largely thanks to the inflationary pressures which will inevitably follow the energy crisis, and some markedly hawkish rhetoric from the governor of the Bank of England. According to interest rate markets, there is now an 85% chance of a rate rise this year, and a 60% chance of a hike at the next MPC meeting in November. Markets are pricing in tighter policy because the energy crunch could prompt a dramatic U-turn on interest rate policy at the Bank of England.

“There does certainly seem to have been a significant shift in rhetoric coming from the Bank, but there may yet be some prevailing factors which push an interest rate rise into next year. The Bank’s rate setters will want to see what the economy looks like after the sticking plaster of furlough has been properly removed, and how much legs the energy price crunch has left. The Bank may well be wary that rising energy costs will act as a brake on economic growth, which will do a similar job to an interest rate hike, thereby alleviating the need for tighter policy just yet.

“There’s also the human element to consider. The Bank’s interest rate committee voted unanimously to keep interest rates on hold less than a month ago, so a 2021 rate rise would require a pretty humbling collective shuffle across the aisle. It’s also important to note that elevated inflation right now doesn’t necessarily undermine the Bank’s stated view that it is transitory. As of their last forecast, the Bank was expecting inflation to rise to 4% this winter, and still be 3.3% in Q3 of next year, and that elevated level was consistent with a rate rise only in the back end of 2022.

“Even if we don’t get a rate hike this side of Christmas, tighter monetary policy is firmly on the agenda in financial markets. Savers and investors should therefore take stock of their finances, because an environment of rising interest rates is going to be a shock to many. Indeed a whole generation of young adults won’t even remember a time when bank rate started with anything other than a zero. Around 10 million people in the UK haven’t seen interest rates above 1% in their adult lives, seeing as the last time base rate was at this level was in February 2009.

“The next interest rate decision takes place on the 4th November in the UK, just one day after the more influential Federal Reserve will announce its stance on tightening US monetary policy. Guessing how nine people in a room are going to vote on interest rate policy isn’t based on any science, but a rate hike in November would give the impression of a pretty panicked knee-jerk reaction to events unfolding in the energy market. A December hike therefore looks more likely, but there’s still a lot of data to enter on the Bank’s spreadsheet before then. When the time comes, the central bank will want to take a slow and low approach to tightening policy, so as not to cause any frogs to leap out of the simmering pan. Market prices will move ahead of the Bank of England however, which goes some way to explaining why gilt yields have more than doubled in the last two months.”

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