Reflecting on September: BoE sparks rally

Bank of England triggers sharp moves in sterling and UK gilts

What has happened?

The Bank of England sparked a rally in sterling and a sell-off in UK government debt in September as several members of the Bank’s Monetary Policy Committee (MPC) suggested that the time was approaching when it will be appropriate to raise interest rates.

Why?

UK inflation in August came in higher than expected, rising 2.9%, year-on-year, above the Bank’s 2% target. Other economic data points were also better than expected, including retail sales, unemployment figures and consumer confidence. Also, with other major central banks beginning to pursue tighter monetary policies, and global equilibrium interest rates potentially rising, Bank of England Governor Mark Carney remarked that the MPC may have to “move in order to stand still”.

What should you take away from it?

Following the stronger than expected economic data and hawkish commentary from the Bank of England, the market, based on Overnight Indexed Swaps, sharply repriced the probability of a rate rise in the UK before the end of the year. The probability of a 2017 rate increase on 30 August stood at 23% and has risen to 81% as at the time of writing. Beyond the end of 2017, expectations are that the Bank will be reluctant to embark on a series of quick rate hikes, with the market implied probability of a second rate rise next year only modestly above 50%. This is in line with recent comments from Mark Carney who, while seemingly advocating tighter monetary policy, has said that he expects the tightening cycle to be “gradual and limited”.