An economic bounceback, but no rate rises

Laith Khalaf
18 March 2021

•    The MPC has voted unanimously to keep interest rates at 0.1% and maintain the QE programme
•    Interest rates look set to stay nailed to the floor, despite expectations of a robust economic recovery
•    But markets are beginning to fear inflation and are taking matters into their own hands

Laith Khalaf, financial analyst, AJ Bell:

“Since the beginning of last month, markets have gone from worrying about negative interest rates in the UK, to pondering when monetary policy might tighten. The Bank of England provided a pretty bullish assessment of the prospects for economic recovery in its February monetary report and since then the outlook has got even better. Further support from the Chancellor in the Budget, a roadmap out of lockdown and fiscal stimulus spilling over from the US, all support the case for a robust bounceback, as the UK economy opens up in the coming months

“But the message coming through from the Bank of England is that interest rates are going to remain nailed to the floor for the foreseeable future, despite the improving economic picture. The only thing that might prise rates upwards is a bout of inflation, but that would need to be both sustained and structural to compel the Bank of England to tighten policy. The Bank will look through rising inflation caused by temporary factors, such as recovering energy prices and would only deem inflation to be problematic if the UK was near full employment, which isn’t going to happen this year, or probably next.

“That’s an issue for people who’ve amassed cash savings throughout lockdown, as low interest rates and rising inflation spell a loss of buying power. That will encourage savers to spend money in the real economy, which is of course part of what the Bank is trying to achieve with low interest rates. However, the Bank estimates that consumers will only spend 5% of their excess savings from the pandemic, leaving most untouched and potentially lagging behind price rises, in bank accounts offering next to no interest. 

“Meanwhile the market is taking matters into its own hands, with the 10 year gilt yield rising to its highest level since the middle of 2019, reflecting concern that inflation could be on the cards. Gilt yields are still extremely low, but the central bank will be hoping these inflation worries remain contained, as rising market rates could serve to choke off economic recovery, because borrowing costs would rise for consumers and businesses. The Goldilocks scenario is that the economy runs not too hot to cause rampant inflation and not too cold to cost livelihoods. But markets are beginning to price in the risk of higher inflation and those fears won’t be soothed by the fact that CPI will rise in the coming months, as energy price falls seen in the spring of last year begin to fall out of the equation.”

Laith Khalaf
Financial Analyst

Laith Khalaf started his career in 2001, after studying philosophy at Cambridge University. He’s worked in a variety of roles across pensions and investments, covering both the DIY and the advised sides of the business. In 2007, he began to focus on research and analysis, and has since become a leading industry commentator, as well as a regular contributor to the financial pages of the national press. He’s a frequent guest on TV and radio, and for several years provided daily business bulletins on LBC.

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