Chris Arcari, Head of Capital Markets, Hymans Robertson, said: Why rates were held: “The BoE isn’t targeting realised inflation – it’s targeting where inflation is expected to be on its forecast horizon. A reduction in the energy cap versus last autumn’s large increase is expected to show headline inflation fell to 4.7% year-on-year in October. Goods prices are also expected to fall further, given weak producer-price inflation, with food-price inflation also expected to have moderated sharply. Meanwhile, UK PMIs point to a weakening in UK economic activity that should put further downwards pressure on inflation. However, sticky core inflation and strong wage and service-price growth are likely to keep the BoE cautious about cutting rates over the next few years. Interest rates are likely to stay higher for longer – as policymakers have indicated, the near-term interest-rate profile is expected to look more like Table Mountain than the Matterhorn.”
“Longer-term bond yields have also risen – much more so than shorter-dated yields. One might be tempted to assume this represents a de-anchoring of much longer-term inflation and interest-rate expectations. But inflation expectations haven’t risen very far over recent months. Instead, the rise in long-term bond yields appears to represent an increase in the ‘term premium’ – the additional compensation for investors to hold a long-dated instrument to maturity, rather than rolling a short-term deposit. Put another way, it’s the yield over and above what’s expected from the average of future short-term interest rates.”
Impact on pensions: “Rises in long-term bond yields, of course, go hand in hand with declines in the value of long-term bonds. But viewing pensions purely from the asset side is incomplete, in our opinion. A rise in long-term yields will reduce the value of a defined-benefit pension pot from a member’s perspective, but that’s because the rise in long-term yields has reduced how much it costs in today’s money to provide promised, fixed benefits. Indeed, that’s why, on average, defined-benefit pension scheme funding levels have improved rapidly over the last two years – higher yields mean the promised pensions are ‘discounted’ at a higher rate, so the overall liability has fallen (in most cases, more than assets have). Similar thinking can also be applied to defined-contribution pension pots. For those heavily invested in long-term bonds, the value of their pots will have declined over the last two years. However, longer-term yields mean annuity rates have risen rapidly, so it’s now cheaper to buy a retirement income.”
Shweta Singh, Chief Economist, Cardano, said: “As expected the Bank of England (BOE) kept the policy rate on hold today (2nd November) and joined the Fed and the ECB in signaling that its rate hike cycle has ended.
“While our base case a month ago was for another rate hike, economic and price data since then has served up a surprise on the downside. There are four strong reasons why the BOE can afford to wait and watch the lagged effect of its tightening cycle: monetary policy is in restrictive territory, economic momentum is deteriorating rapidly, the labour market is weakening and disinflationary pressures are kicking in.
“A host of indicators show that the labour market is starting to loosen, including vacancies, pay-rolled employment, and wage growth. This is despite data on labour market tightness having been patchy last month, due to the low response rate to the Labour Force Survey, while annual wage growth remains above the BOE’s forecast.
“Last month’s REC Survey recovered slightly but overall remains depressed, which suggests more weakness ahead in the labour market. Wages in the private and services sectors are a better cyclical indicator of labour market conditions than overall wages, and both have slowed meaningfully on a three-month sequential basis.
“Inflationary pressures are now past their peak, and we expect headline inflation to drop sharply in October on the back of energy-related base effects. Nonetheless, the BOE retained its hawkish forward guidance. Despite progress on disinflation and rebalancing the labour market, there is still a long way to go before inflationary pressures are firmly back to the BOE’s target.
“While we expect a recession in the UK early next year, we do not expect policy rate cuts until Q3 2024.”
James Lynch, fixed income investment manager at Aegon Asset Management, says: "Bank of England have kept policy rates on hold at 5.25% for the second month in a row, with a 6-3 MPC split, 6 voting for unchanged rates and 3 for a hike.
"This was expected by the market with little priced for anything other than unchanged policy rates. The reality is inflation has fallen fast from 11.1% to 6.7% and should be in the 4% area into the end of year, at the same time we are seeing economic activity indicators showing signs of concern. The BoE are getting comfort from indicators such as the low PMIs and the softening labour market that the rise in interest rates we have seen to 5.25% is showing that the policy rate is sufficiently restrictive.
"I would expect the chances of getting another interest rate hike in this cycle is very low as the momentum in the economy and future indicators point to lower activity while inflation is falling. The question should now be when will the BoE cut and how bad the outlook needs to be in order for the guidance from the BoE to change away from the current ‘pause’."
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