- Inflation in the UK fell to 1.7%, its lowest level in three years, surprising even the Bank of England
- Chances of a November interest rate cut are now 92%
- UK GDP Growth remains robust as does the labour market despite interest rates being kept higher for longer
The UK has had a week of positive economic data with the unemployment rate dropping to 4.0%, the lowest it’s been in 6 months and retail sales surprising strongly to the upside. However, the biggest news was that inflation is finally back below the Bank of England’s target rate of 2%. Falling from 2.2% in August, CPI came in at 1.7% surprising both the market (1.9% forecast) and the Bank of England (2.1% forecast).
The fall in fuel prices is the main driver behind this drop but we do expect these to come back a little before the end of the year in light of the energy price cap rise and increasing tensions in the Middle East. The chart below shows how CPI has cooled over the last 2 years:
Implications on the interest rate
Economist consensus was that we’d likely see one more interest rate cut from the BoE in November followed by uncertainty in December but this has quickly evolved into an all but guaranteed November cut with another one in December very likely (79%).
The Bank of England were quite far off with their inflation forecast and in hindsight they probably should have cut at September’s meeting instead of holding. There is a world, albeit unlikely, that we see them enact a double interest rate cut (0.5%) in November to make up for this. Andrew Bailey, the Governor of the BoE has said previously that they could be ‘aggressive’ with rate cuts if the data allows.
The caveat is that the labour market remains strong as evidenced by this week’s unemployment data print, and economic growth is resilient as evidenced by last week’s GDP print of 1.0%. Just six months ago GDP growth was negative at -0.2% year on year.
The market still expects interest rates to be at 3.5% in one years’ time, as shown in the below chart, but this could quite easily be 3.0% or 3.25% if the data carries on this way.
Source: JPMorgan Guide to the Markets
Bowmore Portfolios
We believe that interest rates in the UK could fall below market expectations over the next 1-3 years. This creates a lot of opportunity in our fixed income exposure as the value of bonds rises as rates (and yields) fall. The asset class is extremely attractive even if rates fall in line with expectations and we have been adding to it lately.
We have also increased the duration in our UK gilts, which essentially increases their sensitivity to interest rate changes. We retain our overweight to UK Equities as well given that economic growth is already improving and this should be further boosted by ‘aggressive’ rate cuts.
