Yesterday’s Bank of England (BoE) meeting may have felt unsurprising, but has implications for both the economic backdrop and for the investment landscape.
The economist view – Melanie Baker
The Bank of England (BoE) don’t tend to tell you what they are going to do next, but they have been hiking rates in response to persistent inflation pressure. Their core messaging remained the same: “If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.”
However, there was a bit of a difference in the message beyond the above. We did get new inflation forecasts from the BoE. Historically, their central case forecasts for inflation – incorporating a particular ‘market’ profile for rates – has been a key way for observers to draw signals about BoE policy intentions/expectations. They heavily referenced their forecasts in the press conference, but the signalling was rather murky. More than once, they emphasised that there are multiple interest rate paths to get inflation sustainably back to target. There was even some opening the door to a prolonged pause: They made more than one specific reference in the press conference to the version of their inflation forecast that uses a constant interest rate at today’s 5.25%. In that mean forecast, CPI inflation is 2.0% two years from now and 1.8% in three years, i.e. inflation is brought back to target.
The economic backdrop isn’t obviously consistent with a pause or even only one more hike; by UK standards, the unemployment rate remains very low and business surveys look consistent with continued private sector output growth. Meanwhile, inflation remains high, whether looking at headline inflation, core inflation, services inflation or wage inflation. However, those business surveys have been softening and the Monetary Policy Committee acknowledged in the minutes that there were some signs that the labour market was loosening. There was some emphasis in the press conference too on the Bank’s judgement that monetary policy was restrictive and that there was evidence of the effects of monetary policy coming through.
With domestically driven inflation pressure still looking strong, I continue to think we aren’t quite at peak rates in the UK and pencil in another 0.25% rate rise this year. Much, of course, will depend on how the data evolves – as it will for all the major central banks.
The multi asset view – Trevor Greetham
Base rates at 5.25% make cash a compelling asset class in its own right, offering a decent return and a high degree of capital security. However, investors need to appreciate that base rates aren’t likely to stay at these levels forever. We expect UK interest rates to average around 3.5% over the next 10 years. As multi asset investors, we expect better returns from all of the other asset classes in our armoury over this time horizon (see chart below). Near term, we believe that stocks are likely to continue to beat cash by a wide margin if the economies avoid recession and experience a so-called soft landing. In a hard landing scenario, we think government bonds are likely to beat cash as yields drop.
Chart: Royal London Asset Management capital market assumptions over 10 years ranked from highest-lowest
Source: Expected risk and return based on Royal London Asset Management's capital market assumption as of June 2023. Gross of fees.
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