City Economists Doubt Markets' Bank Rate Forecast

Several City economists say financial markets have gone too far in predicting how much the Bank of England will lift interest rates over the next year.

Market pricing points to at least four rises, taking the bank rate from 3.75% today to 4.75% by the end of July. By December 2027 it could reach 5%, which would mean five rises. The economists doubt that path, because there is little sign that higher energy costs are pushing up other prices sharply.

James Smith, a developed markets economist at ING, said the swaps market implies four hikes "and then no cuts ever". He added that he would struggle to find anyone who agrees with that. In his view the Bank could be "sounding the all clear" by next spring and cutting rates again by the end of next year.

Oil prices drive the pricing

Market-implied rates are worked out from the prices of financial instruments such as swaps. Since the Iran war began, they have tracked oil prices closely: the higher oil goes, the more rises are priced in. Smith said traders who bet against that face losses and possible margin calls if oil keeps climbing, so many are reluctant to take the risk until energy supply and winter inflation are clearer. Many were caught out at the start of the Middle East crisis, he said, when most expected more cuts this year.

Sanjay Raja, chief UK economist at Deutsche Bank, said he does not believe any mainstream forecaster expects a rise to 5% by the end of next year. He calculates that much of the priced-in increase is "baked-in risk premia", the extra return investors demand to cover uncertainty. Without it, he estimates only about half a percentage point of rises remains. Deutsche Bank expects the rate to reach 4.25% by next February and stay there to the end of 2027.

What banks forecast

The Bank is widely expected to raise rates to 4% at its meeting on 5 November, after UK inflation rose to 3.5% in September. Goldman Sachs also expects 4% next month and says its forecast path sits well below market pricing. Morgan Stanley expects rises in November and February, then a hold, although a larger-than-expected national living wage recommendation from the Low Pay Commission could add pressure.

Oxford Economics forecasts quarter-point rises in November and February, taking the rate to 4.25%. It describes that as well below the 4.75% to 5% peak in money market expectations.

Even Huw Pill, the Bank's chief economist, has suggested expectations are running too hot. At an International Monetary Fund meeting in Bangkok this month he said he was sceptical the Bank would need four rises over the next year.

Source: The Guardian