Views From the Marsh

Who are these experts in the UK rates markets? - David Owen

According to a survey of 72 market participants undertaken by the BoE between 29 November and 1 December, the mean expectation is for a 4.5% Bank Rate in December 2024 and 3.5% in two years’ time.

This is a widely shared expectation. The 75th percentile is broadly looking for the same thing - 4.5% in a year’s time, 3.75% in Q4 2025, and 3.5% in Q4 2026. In other words, a sharp reduction in rates, starting in 2024.

This is certainly not a table mountain view of the world, where the Bank Rate remains anchored at it current level for a prolonged period of time, to allow the MPC to become convinced that domestically generated inflation (especially that stemming from the labour market and services) is consistent with the BoE achieving the 2% inflation target in the long term.

And, that is before taking on board the inflation implications of achieving net zero, or the fact that goods price inflation may be higher than was seen prior to the GFC.

This then begs the question, who exactly are these experts, and are their expectations based more on hope, than reality? Rates desks typically achieve more of their annual targets when yields fall; many of those responding to the survey may be geared to what is still a very expensive London housing market, and so may be even more biased towards looking for lower rates.

Wind the clock back to February 2022 shortly after the BoE started raising rates and the 29 respondents to the survey then expected rates to be only 1.5% in three years’ time. Even the 75th percentile was only looking for a 2% Bank Rate by February 2025, and a 1.5% Bank Rate in February 2024. And, that was coming out of furloughing, with what was clearly a very tight labour market.

Of course, those filling in such surveys on trading desks may not be the same as those who set the “house view” for the investment bank in question. The “house view” is more likely set by the economics team, who will likely be taking a much longer term view of things. In some cases, the economics team may spend little time on the trading floor, where desk strategists may make the short-term calls.

For many of the respondents to the BoE survey, getting the long-term view right may be something of an irrelevance (unless it comes to things like the housing market). Being a flow (as opposed to a buy and hold) business, what will be important to many rates desks will be broadly getting the short term moves in the markets right, including sharp changes in market sentiment. And, as already highlighted most such desks do not do well in bond bear markets, or when there is no volatility in the curve.

Gilt trading desks can require lots of capital, which become more expensive to run in higher rates environments, making it even more difficult for them to hit budget (net of costs). This is no longer a pre-GFC world where traders could be given their balance sheets for “free”, being subsidized by the rest of the bank.

A sustained fall in yields at the short end of the curve would clearly be very helpful for 2024’s P&L, as it would for the P&L of their clients, UK fixed income fund managers. Going into year end, business managers will be loathe to suggest that next year could bring significant losses for their businesses, and that capital would be better allocated to other areas.

Meanwhile, anyone following the monetary policy debate in the UK, should have not been surprised by last week’s decision. The three Externals who voted for rate rises had each given a speech recently, making it quite clear where their biases lay. It is a strange world when a monthly GDP world gets more attention than speeches by key policy makers.

The Minutes did highlight MPC thinking that the autumn statement will ultimately boost UK GDP by 0.25 percentage points, but might also improve the supply side workings of the economy, such that there may be little implications for inflation. But more on this should be known when the BoE addresses all such issues in much more detail in their February Monetary Policy Report.

Alongside the Minutes, the BoE also published the results of their latest Decision Maker Panel of CFOs - who have to take a much longer view of things than the average trading desk. Their expectation is for wage inflation of 5.1% in the private sector in a year’s time; a figure unchanged from the summer and not consistent with the inflation target on a sustained basis, with productivity growth of only around 1%.

And, Thursday’s decision was followed by more survey evidence suggesting an economy that was holding up better than many had feared. Of course, a long period of 5.25% Bank Rate brings with it risks, as more things need to reprice.

We now look in detail at one issue, the Buy-to-Let market, alongside Deputy Governor Ben Broadbent’s speech from this morning - arguably again not consistent with the view of market participants.