We’re not yet at peak rates in the UK

Published  03 August 2023
   3 min read

Commenting on today’s Bank of England interest rate rise, Melanie Baker, Senior Economist at Royal London Asset Management said:

"The Bank of England (BoE) doesn’t tend to tell you what it is going to do next, but it has been hiking rates in response to persistent inflationary pressures, and its core messaging has remained the same: ‘If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.'

"However, there was a bit of a difference in the message in today’s announcement in that we saw new inflation forecasts from the BoE. Historically, its central case forecasts for inflation – incorporating a particular ‘market’ profile for rates – has been a key way for observers to draw signals about the Bank’s policy intentions and expectations. It heavily referenced its forecasts in the press conference, but the signalling was rather murky. More than once, it emphasised that there are multiple interest rate paths to get inflation sustainably back to target. There was even some opening of the door to a prolonged pause: the BoE made more than one specific reference in the press conference to the version of its inflation forecast that uses a constant interest rate at today’s 5.25%. In that mean forecast, CPI inflation is 2% two years ahead and 1.8% three years ahead, i.e. inflation is brought back to target.

"The economic backdrop isn’t obviously consistent with a pause or even only one more hike; by UK standards, the unemployment rate remains very low and business surveys look consistent with continued private sector output growth. Meanwhile, inflation remains high, whether looking at headline inflation, core inflation, services inflation or wage inflation. However, those business surveys have been softening and the MPC acknowledged in its minutes that there were some signs that the labour market was loosening. There was some emphasis in the press conference too on the Bank’s judgement that monetary policy was restrictive and that there was evidence of the effects of monetary policy coming through.

"With domestically-driven inflation pressure still looking strong, I continue to think we aren’t quite at peak rates in the UK and pencil in another 25bp rate rise this year. Much, of course, will depend on how the data evolves – as it will for all the major central banks."

From an investment perspective, Trevor Greetham, Royal London Head of Multi Asset added:

"Base rates at 5.25% make cash a compelling asset class in its own right, offering a decent return and a high degree of capital security. However, investors need to appreciate that base rates aren’t likely to stay at these levels forever. We expect UK interest rates to average around 3.5% over the next ten years. As multi asset investors, we expect better returns from all of the other asset classes in our armoury over this time horizon (see chart below). Near term, stocks are likely to continue to beat cash by a wide margin if the economies avoid recession and experience a so-called soft landing. In a hard landing scenario, government bonds are likely to beat cash as yields drop."

Chart: Royal London Asset Management capital market assumptions over 10 years ranked from highest-lowest

Source: Expected risk and return based on RLAM’s capital market assumption as of June 2023. Gross of fees.

The views expressed are the author’s own and do not constitute investment advice.

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About Royal London Asset Management (RLAM):

Established in 1988, Royal London Asset Management (RLAM) is one of the UK's leading fund management companies, providing investment management solutions to both wholesale and institutional clients such as not-for-profit organisations, local authorities and the insurance sector.

RLAM manages £153 billion of assets as at 30 June 2023. It invests in all major asset classes including UK and overseas equities, government bonds, investment grade and high yield corporate bonds, property and cash.

Issued by Royal London Asset Management Limited, registered in England and Wales number 2244297; authorised and regulated by the Financial Conduct Authority. Registered Office: 80 Fenchurch Street, London, EC3M 4BY.

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