David Roberts

Brexit caution should not delay rate hikes

David Roberts

Mark Carney surprised markets yesterday with comments suggesting a widely expected interest rate hike in May is not a done deal.

Having voted against hiking rates in March and warning of ‘faster and sooner’ rises back in February, many assumed a 0.25% increase was all but nailed on for the Monetary Policy Committee’s May meeting.

But the Bank of England Governor highlighted “mixed data” in the UK and said he is focusing on the general path of rate rises rather than precise timing, allowing policymakers to keep the economy on a stable path in the face of upcoming Brexit decisions.

Sterling has weakened after these comments while Gilts recouped some of their recent losses and the bond marketing is now pricing in less than a 50% chance of a hike in May.

Our view on this is a simple one: rates need to rise.

Carney says he wants to wait and see what Brexit means for the UK but I have news for him: it means less economically than most of us think.

A ‘poor’ Brexit scenario would see a sterling collapse leading to imported inflation and a rise in manufacturing output; a ‘good’ result would see the service economy (at full employment already) expanding and domestic inflation edging up. Either way, interest rates need to rise.

Bond market reaction to Carney’s caution has not been universally positive, with long-dated paper underperforming. The market is worried no rate rises means a greater chance of inflation and investors therefore want a bigger premium to lend money to the government over long terms.

In this environment, we remain strategically short interest rate risk and would to look to add to that position tactically if Carney fails to pull the rate trigger.

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Friday, April 20, 2018, 2:05 PM