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UK interest rate hike looms sooner than expected

Don’t rule out a UK rate rise in 2014, says Thant Han, portfolio manager at US-based Standish, a BNY Mellon company. Meanwhile, a mid-2015 interest-rate hike looks more likely for the US as ‘tapering’ remains on track…

We believe the chances of a UK interest-rate hike by the end of this year are rising. The general consensus is an early 2015 rise but there is plenty to support earlier action from the Bank of England (BoE): from unemployment being down to the BoE’s forward guidance range, the very real prospect of above-trend growth by the end of 2014, to stable inflation – there are positive signs for the UK economy. On the inflation front, a headline rate consistently near or above the Monetary Policy Committee’s (MPC’s) target over the rest of this year is likely to create pressure on the MPC to act.
 
Another aspect to consider is the UK housing market. A booming market in London and the South East has created a positive wealth effect and had a knock-on impact on both sentiment and consumption – we expect the housing demand to continue to drive growth over the course of the second half of 2014. Many commentators point to ‘Help to Buy’ and the ‘Funding for Lending Scheme’ as an inflator of the housing market, in particular, but BoE Governor Mark Carney can only control the supply of money; the government is responsible for the supply of houses.” It’s the lack of the latter that has sharply driven up prices relative to incomes – quite simply, demand is outstripping supply. Meanwhile, talk of a UK housing bubble is misleading; it is very much a South-East England phenomenon.
  
Across the Atlantic, we expect the US Federal Reserve (Fed) to continue ‘tapering’, all things being equal, at the current rate of USD10bn a month. This means that, in the absence of any negative ‘surprises’ this puts the Fed on track to complete its wind down of the asset purchasing programme by the end of 2014. Against this backdrop, we agree with the consensus view that a US interest-rate rise is unlikely until mid-2015 at the earliest. However, we think the timing of a hike depends on the evolution of the labour market over the second half of this year, coupled with the broader inflation picture.
 
On both the ‘tapering’ and rate rise fronts, the Fed’s rhetoric has been very methodical. While tapering was teed up via forward guidance, the Fed is very happy to hold up hiking rates until domestic factors dictate. It is also important to remember that tapering is not monetary tightening – it is a shift from balance sheet expansion to balance sheet maintenance, not contraction. Fed rhetoric has become a tool in ‘talking down’ asset markets. Indeed, there has been reluctance among Fed members to move to a more quantitative approach to forward guidance, in favour of a more flexible qualitative approach.

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