Bank of England rate cut bets surge as inflation could hit 2.0% target within months
PoundSterlingLIVE
Published Dec 20, 2023 10:07
Bank of England Rate Cut Bets Surge As Inflation Could Hit 2.0% Target Within Months
PoundSterlingLIVE - Bank of England rate cut bets have surged in the wake of December's inflation release that showed price pressures were easing rapidly in the UK and could fall to the 2.0% target in a matter of months.
The fall in headline CPI inflation to 3.9% year-on-year in October was met with a frenzy of bets on money markets that showed investors now see the first Bank of England rate cut falling in May of 2024.
"We continue to expect the MPC to reduce Bank Rate by 25bp initially in May, and then at alternate meetings thereafter," says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.
The scale of the undershoot in all elements of the inflation data caught markets and economists off guard, with the all-important core CPI rate printing at -0.3% month-on-month, which was well below October's 0.3% and the expected 0.2%.
Reacting to the inflation surprise, the overnight index swaps (OIS) market showed investors added to rate cut bets for 2024 and 2025:
The OIS market implies investors are now looking for roughly five cuts in 2024, with the bank rate falling from 5.25% to around 4.0%, followed by four more cuts in 2025 to a year-end rate of c3.0%.
As the chart above shows, this is materially more than was expected just days ago.
The repricing lower in interest rate expectations has boosted UK bond prices, which has corresponded with falling bond yields, which has weighed on the Pound. "With more rate cuts priced in, GBP, to no surprise, is falling," says Thanim Islam, Head of FX Analysis at Equals Money.
Looking ahead, CPI inflation looks set to continue to fall more quickly than the Bank of England predicted in November. Pantheon Macroeconomics says the headline rate of CPI inflation will drop to about 3.8% in Q1 and then to 2.0% in Q2, substantially below the MPC’s forecasts of 4.4% and 3.6%, respectively.
"This will support a sooner and swifter reduction in Bank Rate than the MPC has countenanced to date, though we still think uncertainty over the scope of fiscal loosening in the Budget and the impact of next April’s increase in the National Living Wage on overall wages will mean that the MPC will not cut Bank Rate at its next meeting in early February," says Pantheon's Tombs.
Despite the fall in inflation, some economists warn market expectations for the timing of the first rate cut in May, as well as the total for 2024, are excessive.
"We expect the Bank of England to face more intensive debate about when it can cut interest rates, but to try and push against this whilst it waits for reassurance that the inflation battle really has been won," says Victoria Clarke, UK Chief Economist at Santander (BME:SAN) CIB.
Santander says the Bank of England will only gain the comfort it needs to start cutting interest rates in summer 2024, implying rate cut expectations must reverse at some point.
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Clarke says although inflation is set to trend lower from here, "the trickier problem for the Bank of England is that services inflation is still elevated, and pay growth too, making it difficult for the BoE to conclude inflation will stay at low rates."
An original version of this article can be viewed at Pound Sterling Live
Written By: PoundSterlingLIVE
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