- Markets now expect three interest rate cuts from the Bank of England this year
- Falling interest rate expectations should feed through into cheaper mortgages
- Cheaper oil is deflationary for the UK
- The exchange rate and retaliatory UK tariffs could push up inflation
- It’s too early to speculate on what this might mean for Rachel Reeves’ next Budget
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“Trump’s tariff announcement might have created havoc in the stock market, but there could be a silver lining for UK mortgage borrowers. Interest rate expectations are falling as markets price in the potential economic damage from US tariffs, and the likelihood the Bank of England will respond with interest rate cuts.
“The market had been pricing in two interest rate cuts this year, but in short order that has now been ratcheted up to three, which would take the base rate to 3.75% by the end of 2025 (based on LSEG data). Meanwhile the two year swap rate fell from 4% on 1 April to 3.7% at the end of last week, according to Bank of England data. The two year gilt yield has also fallen, from 4.2% to 3.9% since 1 April (source: LSEG). We may therefore see falling interest rates feeding into mortgage pricing before too long. Likewise the cash market may see fixed rates fading to reflect the new outlook for interest rates.
“Of course, there’s clearly a high degree of uncertainty around whether current market dynamics will be sustained, not least because Donald Trump has already shown some flexibility around tariffs in the short time he’s been in office and will likely be getting calls from wealthy backers who have seen billions of dollars wiped off their wealth in the last few days. He may well stay the course, but then again, if he adjusted his trade policy in the face of plummeting stock markets, it wouldn’t come as a total surprise.
“The Bank of England will be keenly aware the inflationary outlook isn’t entirely one-sided. Cheaper oil will push down on UK inflation, giving the Bank of England scope to cut rates without worrying about rising prices. Likewise cheaper goods flowing into the UK instead of the US could help dampen inflation. However on the flip side of the coin, exchange rate movements could create inflationary headwinds. The immediate response to Trump’s tariffs was a sell-off in the dollar, but there has been a recovery and now the pound is trading at $1.28, below the level it stood at before Trump’s announcement. Supply chain disruption could also lead to price spikes which feed through into consumer prices. The UK’s reaction to the imposition of tariffs also matters. Should the UK impose its own tariffs on imported US goods, that could push the inflationary dial upwards. If that happens, markets might well start to walk back on the rate cuts they’re expecting.
“As the Bank of England said in its February Monetary Policy Report, ‘while tariffs are likely to lower UK economic activity, the overall effect on UK inflation is unclear.’ This highlights the difficulty in predicting the fallout from a trade policy as wide-ranging as that announced by President Trump. It’s still early days and markets are digesting an enormous shift in US economic policy. There is a huge array of moving parts, so making definitive predictions on inflation is incredibly challenging, though it’s something the Bank’s rate setters will soon have to grapple with. The next interest rate decision by the Bank of England is a month away, which gives some time for the dust to settle and for policy makers to reach a more considered decision than they might be able to muster right now. For what it’s worth, the market is now fully pricing in a UK rate cut in May.
“As things stand tariffs are likely to knock the OBR and Bank of England’s economic growth forecasts off course. That may wipe out the fiscal headroom for the chancellor, but it’s not a done deal because lower interest rates would bolster the Exchequer’s coffers. It’s also a very, very long way until October when we might expect the next fiscal event, by which point the global economic picture could be very different. It’s therefore way too early to speculate on what money the chancellor may or may not have to conjure up to balance the books at the next Budget.”
