- Markets are now pricing in just one rather than two interest rate cuts this year
- Longer term forecasts for interest rates have risen too
- Next week’s meeting could be a banana skin
- What this means for mortgages and savers
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“The sizeable fiscal loosening announced by the chancellor has prompted markets to pretty much rule out two interest rate cuts this year. Previously market expectations were for the base rate to fall to 4.5% by the end of this year, and then to under 4% by the middle of 2025. But the inflationary nature of the measures announced in the Budget are forecast by the OBR to add 0.4% to CPI inflation in the next tax year, thereby putting pressure on the Bank of England to keep rates at higher levels for longer. Indeed, the OBR has added 0.25% to its forecasts for interest rates over the next five years to accommodate the effects of the Budget, which suggests the impact is not simply going to be a short-term blip.
“Markets are still pricing in a rate cut from the Bank of England in November, but think that will be the lot for this year. Although rate expectations have been scaled back, the forthcoming interest rate decision feels like it might be a banana skin, where markets take a tumble. Expectations of rate cuts were previously heightened by some dovish rhetoric from Andrew Bailey, and a benign inflation reading for September, with CPI coming in under the Bank of England’s 2% target for the first time in three years. That was just one month’s reading, and reflected life before October’s rise in the energy price cap. We’ve also had the Budget which looks to have materially changed the inflationary path and may well make the Bank’s rate-setters sit on their hands for the time being. At the last meeting, eight of the nine members of the rate-setting committee voted to keep rates at 5%, so there’s not much evidence of policy makers peeling off either.
“Of course, markets are especially sensitive to the effect chancellors can have on interest rates ever since Kwasi Kwarteng took to the despatch box, and with the ten-year gilt yield now climbing to levels seen in the wake of mini-Budget, it’s fair to ask whether Rachel Reeves’ maiden Budget could cause similar problems. The answer is probably, and hopefully, not. The scale and speed of rises in gilt yields has not been the same as it was in September 2022, giving markets time to adjust to lower prices. We don’t know precisely how inflationary the mini-Budget was, because Liz Truss and Kwasi Kwarteng chose not to ask the OBR to publish their accompanying analysis. But markets panicked, probably a result of the divergence from due process alongside an inflationary Budget at a time when inflation was much more malign than it is now. The OBR reckons CPI will average 2.6% in 2025. That’s above target, but not by a terrifying amount.
“Nonetheless we can expect some impact from higher rate expectations in the mortgage and savings market. Based on what’s happened to the two-year gilt, we might start to see mortgages creeping up again, just when borrowers thought we were on a firmly downward path. However, rates are still more affordable than they were, with some fixed rates coming in under 4%. That at least gives borrowers a better base if rates do tick up a bit. On the other side of the ledger, savings rates can be expected to get a boost from the Budget and the adjustment to interest rate expectations. Higher cash rates aren’t exactly going to fund an early retirement, but savers can probably sit on their coffers a bit more comfortably, for a while at least.”
