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Has the Boris bounce delayed a cut in UK interest rates?

31 January 2020

MPC hold rates

Yesterday the Bank of England (BoE) Monetary Policy Committee (MPC) voted 7-2 to keep the base rates on hold at 0.75%. The two dissenting votes were in favour of a cut. Prior to the meeting, the market predicted a 45% chance of a rate cut and a greater degree of dissent. Whilst growth slowed and business investment remained sluggish, recent survey data has indicated more confidence in the market outlook. Hence, the MPC predict a pick-up in investment and in the property market. The US-China trade deal has cleared some headwinds and there are early signs of global growth picking up. The Federal Reserve also held interest rates on Wednesday, despite continuing calls for lower rates from the White House. As BoE Governor, Mark Carney, remarked following his final MPC meeting, “This is less of a case of so far so good, and more a case of so far, good enough”. However, the MPC notes that if this does not follow through, then a rate cut later in the year is possible. Before the next BoE meeting, we will get the budget announcement from the Chancellor, which is expected to be simulative and could remove the need to ease monetary policy.

Key risks

For the UK economy, there are two headline risks. The first being the spread of Novel Coronavirus and the impact that the measures taken to counter it could have on the global economy. The second being, domestically, concerns that the Boris bounce after the election may not follow through. As the risk of a Labour government receded, with its less business friendly policies, confidence across the economy picked up. The subsequent passing of the Brexit deal does remove some of the uncertainty that has delayed investment decisions. However, for the Boris bounce to be sustained, we need to see progress on a comprehensive trade deal with Europe.

Market response

Following the announcement that rates would remain unchanged, the pound rose about 0.5% against the US Dollar and gilt yields moved higher. This was most marked at the short end with two year yields rising by 9bp. News on the spread of the Novel Coronavirus was already weighing on equity markets, but the rise in yields and the pound caused a further decline of 0.4% in the FTSE 100 in the half hour following the news.

Post-election, there were substantial inflows into the UK equity market and international investors who had shied away from the UK appeared to have renewed interest. With a prospective price earnings ratio of around 12 (against the US at 17) and a dividend yield of 4.7%, the UK continues to be cheap relative to gilts and other developed market shares.

Next steps

The Boris bounce and US trade deal has improved the outlook and enabled the BoE to delay a rate cut for now. However, the future course of interest rates may be determined by real economic numbers rather than the survey data alone. If the pick-up is sustained, the MPC may be on hold for a long time and the next move may be up rather than down.

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