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90% chance of rate hike, but markets are ‘pretty rotten at predictions’

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Written by: Paloma Kubiak
27/07/2018
There’s a nine in 10 chance the Bank of England will raise interest rates above 0.5% at next week’s meeting but analysis reveals the markets have been pretty poor at predicting bank movements in the past.

There has been much speculation as to whether the Bank of England’s Monetary Policy Committee (MPC) will raise interest rates at its next meeting on 2 August. If so, this would be the first time since the financial crisis that the rates have moved above 0.5%.

At its last meeting in June, the MPC voted by a majority of six to three to maintain the Bank Rate at 0.5%, in line with expectations.

But since then, a raft of economic data has recently undermined the case for a rate rise and the Brexit debacle has also rocked the boat.

However, the market is still confident of an August rate rise, suggesting a nine in 10 chance that the MPC will tighten its policy.

Laith Khalaf, senior analyst at Hargreaves Lansdown, said the markets have “previously proven to be pretty rotten at predicting the course of monetary policy”.

He said: “Back in 2009, shortly after interest rates were cut to 0.5%, the market expected a rebound to around 4% by 2012. More recently, in the spring of this year, interest rate markets had pencilled in a May rate hike, which never materialised, of course.

“Joe Public is at complete odds with the market on this point, with nine out of ten UK households expecting no rate rise, according to a recent survey from IHS Markit.

“In reality the balance of probabilities lies within these two extremes. The Bank would dearly love to normalise monetary policy, if only to give itself a bit of ammunition to ward off an economic slowdown. Moreover, last time the MPC met, three members voted for a rate rise, which now means only two doves need to become hawks for policy to tighten.”

Khalaf said that since interest rates were cut to 0.5% in March 2009, the market has consistently expected interest rates to rise faster than they have. When looking forward three years into the future, markets have over-estimated interest rates to the tune of 1.6% on average over this period.

He said: “The last 10 years have been characterised by extraordinary monetary policy, which goes some way to explaining why the markets have got it so wrong. But just as a watched pot never boils, spikes in expectations over the years have been followed by stubbornly cool monetary policy.”

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