Bank of England to Raise Interest Rates in Q4 say Lloyds

The Bank of England will raise interest rates in late 2015 say analysts at Lloyds Bank.

Researchers say that the prospect of deflation in coming months will ultimately not sway decision makers on the Bank of England’s MPC.

Deflation is forecast to be temporary by Lloyds researchers; a view shared by the Bank of England itself.

Recently sterling has come under pressure with markets gauging that the fall in inflation will delay the first rate hike further.

Markets are now pricing in the first interest rate lift in the first quarter of 2016.

If Lloyds is correct in maintaining their forecast for a rate hike at year-end 2015 then markets may ultimately be undervaluing the British pound at the present time.

Why the Bank will Raise Rates in 2015 According to Lloyds

Despite earnings growth slowing to 1.8% on the headline 3m/12m rate from 2.1% previously, and the unemployment rate holding at
5.7% against expectations of a dip, “we continue to see the broad trends as being consistent with the ongoing absorption of the economy's spare capacity,” say researchers.

Analysts say this economic trajectory still seems likely to warrant a tightening in policy by the BoE in 2015 Q4, by which time the weakness in the headline inflation rate should begin to unwind, and any incoming government is likely to adopt a less demanding profile of fiscal consolidation than implied by the Budget.

The BoE's policy response to rising medium-term inflation risks from a tighter labour market, alongside a similar move towards normalisation by the Fed - whether it begins in September or June - should allow sterling bond yields to normalise.

“We expect 10-year yields to rise to 2.2% by end-2015 and 2.9% by end-2016,” say Lloyds.

An Interest Rate Increase

What would derail these predictions on interest rate movements will be an interest rate cut.

BoE Chief Economist Andrew Haldane said in mid-March that interest rates could indeed be cut further.

Sterling sank on the news as did yields on UK gilts.

Bank of England policymaker Kristin Forbes this week reported that UK inflation will probably keep on falling now it has hit zero.

As such, the Bank of England could cut interest rates if it falls too far. With interest rates being low people will now start to have more money in their pockets which will lead to more spending.

Forbes does acknowledge that the low inflation will not last too long and as such we see this as being another element of the verbal war against a high exchange rate and rising gilt yields by the Bank of England.

We believe the Bank is inevitably hostage to economics, as should be the case, and fighting an improving economy will not be sustainable.