The pound has continued to rise on currency markets this morning and gilt yields have surged further as further hawkish commentary from the normally dovish MPC policymaker Gertjan Vlieghe built on the unexpectedly hawkish tone yesterday from the Bank of England on the potential for a possible move in interest rates.
A new one year high against the US dollar for sterling as well as further gains against the euro, has also seen 2 year gilt yields hit levels last seen prior to last year’s Brexit referendum of 0.48%. At the beginning of this week they were at 0.18%, a significant shakeout in the interest rate markets.
This is welcome news at a time when there appeared to be rising concern that inflationary pressures might start to become entrenched.
At a time when sterling was looking vulnerable to further losses, and a weak pound helping to fuel inflationary pressure, it was important that the Bank of England sent a signal that they weren’t looking in a different direction to central banks like the European Central Bank, Federal Reserve and the Bank of Canada when it comes to the potential for tightening.
This signalling has gone a long way to help underpin the pound this week, particularly if we get further hawkish rhetoric from these other central banks that suggest they may also look to tighten policy in the coming months. A stronger pound will go a long way to ameliorate rising concerns about higher levels of inflation
It certainly does not mean that we are at the beginning of a potential rate hiking cycle. Moreover this would appear to be an admission that last year’s rate cut was probably counterproductive and caused more harm than good, in terms of rising prices and a squeeze on consumer incomes.
Before we get too excited it is important to note we have been here before on a number of previous occasions, particularly in June 2014 when Mark Carney and the MPC also said suggested that “rates could rise faster than markets currently expect”
It is true that the unemployment rate was much higher at the time at 6.8%, while inflation was lower than it is now at 1.5%, which means the pressure to raise rates was much less given that CPI was below the banks inflation target.
This morning’s intervention by Gertjan Vlieghe an external MPC member, is significant in that he is considered one of the more dovish members of the committee, and his assertion that a UK rate rise may well be needed in the coming months adds weight to the argument that the bank may act by the end of the year.
He also went on to express concern that wage growth might well be on the cusp of increasing, though recent data doesn’t really support that assertion.
It does appear that the assessment from the Bank of England over the last twenty four hours is that their tolerance for higher inflation is becoming limited and much harder to justify especially with unemployment at a 42 year low.
The biggest problem now will be if the central bank rows back its rhetoric in the coming weeks. The response is likely to be unforgiving if the bank cries wolf again, but with rate hike expectations for December currently at 73% bond markets do appear to be realigning for just such a move.
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