Markets pricing in a 40% chance of an interest rate cut this year

•    The MPC has its first meeting of 2021 next Thursday 4th Feb
•    Markets are pricing a 40% chance of a rate cut this year (source: Refinitiv data)
•    How economic data points have moved since the last meeting

Laith Khalaf, financial analyst at AJ Bell:

“The most important thing that has changed since the last interest rate decision is the state of the pandemic. The emergence of the new, more transmissible strain in the UK has prompted another economic shutdown, and pushed back expectations of a recovery. As a result, markets are now pricing in a 40% chance of a rate cut this year.

“Given the picture is still unfolding, the Bank’s interest rate committee will probably sit on their hands for now, particularly seeing as they are running out of monetary policy ammunition. The Treasury is throwing vast sums of money at the economy, and that means monetary policy doesn’t have to do all the heavy lifting. Indeed part of the challenge currently faced by the central bank is that economic data are currently distorted by the Treasury’s coronavirus support measures, and it remains to be seen just how badly the economy has been scarred once these sticking plasters have been removed.

“Further down the line the MPC may decide further stimulus is required, and negative interest rates are one tool they have brandished. At the moment it looks like the Bank are trying to have their cake and eat it; by talking up the possibility of a negative base rate, they are encouraging lower borrowing rates in the market without actually having to shift policy. However, that doesn’t mean that ultimately MPC won’t go there, though this will depend on whether commercial banks can handle negative rates, which the central bank is currently investigating.

“It’s worth noting the negative stock market reaction to the US Fed failing to inject further monetary stimulus in their January meeting. We can continue to expect such tantrums to emerge as and when central banks fail to deliver more liquidity, as market prices are once again largely in thrall to fiscal and monetary policy, rather than company fundamentals.”

Key economic indicators

Sources: ONS, IHS Markit