News in Charts: UK rates – Table Mountain or Matterhorn?

The larger-than-expected decline in UK inflation reported on 20 December prompted investors to reassess the outlook for Bank Rate. Investors now expect several 25-basis-point cuts next year, with the first of those possible in Q1 — current pricing implies a 50% chance of a cut in March. This reassessment sent sterling sliding and the UK stock market rallying; and it came after Pimco, one of the world’s largest bond managers, said that it expects UK rates to come down next year as the economy heads for a hard landing.

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Before the recent inflation figures, the Bank of England’s Monetary Policy Committee and its governor, Andrew Bailey, had been talking down the prospects of looser monetary policy. One UK rate-setter recently said that the path for rates was likely to resemble that of Table Mountain, the iconic, flat-topped mountain in Cape Town: in other words, UK rates were likely to stay high for an prolonged period. One of the reasons that policymakers are reluctant to talk about looser policy is the persistence of above-inflation wage rises, which, while positive for workers’ pockets, is likely to keep some upward pressure on core inflation. This is supported by services inflation, which is falling more slowly than goods inflation.

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But interest rates typically follow a path more like the Matterhorn – steep inclines, followed by steep declines, with little time spent at the top. And analysis by Fathom has also found that investors typically underestimate the pace of policy tightening, both on the way up and on the way down. If history repeats itself then rates will come down even faster than investors currently expect, and a lot faster than the central bank is willing to admit. Ultimately, this will depend on the economy; and a hard landing would bolster the case for sharper rate cuts. To avoid that outcome, the Bank of England may be forced to make a series of earlier and shallower cuts. Perhaps the ideal path for rates looks more Sugarloaf Mountain in Rio than the Matterhorn or Table Mountain.

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The views expressed in this article are the views of the author, not necessarily those of LSEG.

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