Interest rate rise should not deter investors from UK Gilts

Charles Younes, FE research manager

In May, the Bank of England was poised to raise interest rates but decided to hold off at the last moment after a slew of disappointing data. During an April interview with the BBC, Carney reset the expectations for UK Gilts investors, as he was “conscious that there are other meetings over the course of this year.”

Bond markets had been patient in anticipation of the Bank of England’s Monetary Policy Committee decision today to raise the benchmark interest rate by 0.25 percentage points to 0.75 per cent. A decision that has seemed increasingly predictable given that the probability of an interest rate hike had moved to 90 per cent over the summer.

Recent economic data suggests that the UK economy is still expanding (albeit at a slower pace) and the inflation has probably peaked in the first quarter of 2018, as the UK economy has recovered from the first quarter blip. This has proved to be enough to justify this interest rate hike and bond investors will now get more clarity about the future path of interest rates.

Prior to this announcement, reports of this second interest rate hike had created volatility over the short end of the curve but had barely affected the long part. There is little in recent data that would warrant significant revisions to the Bank of England’s UK long term growth forecasts (at least beyond the end of the Brexit negotiation). Mr Carney has made it clear that the Bank of England does not intend to start publishing official forecasts on the future trajectory of rates

However, as suspected it has published, for the first time, its estimate of the “neutral rate of interest”, the rate at which the central bank believes the UK could grow at a sustainable rate with the economy at full employment. In the inflation report, they have confirmed that “the persistence of the fall in the trend real rate means that any rises in Bank Rate are expected to be limited, and interest rates are likely to need to remain low by historical standards for some time to come.

With little sign of improved economic growth or a sudden rise in inflation, UK Gilts investors may make the case that yields won’t rise much from their current levels despite today’s interest rate rise. With still little clarity around the Brexit negotiation and possible economic disappointments to come, we believe it would be premature to completely disinvest from this asset class.

For more information, please contact the FE press office at: James.Hoey@financialexpress.net