BoE meeting: the number of variants considered may increase

With inflation falling faster than expected in the Bank of England's (BoE) November Monetary Policy Report, the change in inflation projections is likely to show that the UK CPI index will fall to the target level of 2% as much as a year earlier than expected. Therefore, conditioning assumptions can mean deeper and faster cycle of interest rate cuts in the next three-year period, leading markets to increase expectations for rate cuts this year. For investors, the dispersion of votes in the Monetary Policy Committee will also be crucial. Even one vote in favor of a rate cut could signal that the possibility of cutting rates has once again become a considered option.

We anticipate that Bailey will strive to maintain a cautious approach, emphasizing the delay in the reading of core inflation and wage growth. However, disinflationary trends combined with less aggressive policy from the Bank of England will lead to a bullish bulge in the UK yield curve, which could extend bond duration.

The BoE's report on monetary policy will carry more weight than Bailey's statements

The main point of interest regarding the meeting Bank of England (BoE) on monetary policy this week, when inflation - like other indicators - will likely be revised downwards, will be a new set of economic forecasts.

According to the November Monetary Policy Report, by the end of 2023, inflation was expected to be 4,6%, unemployment rate to 4,3% and wage growth to 7,25%. Meanwhile, in December, inflation dropped to 4%, the unemployment rate at the end of the year was 4,2%, and wages dropped to 6,5% in November.

November projections indicated that by the fourth quarter of 2025 inflation will return to around the target of 2%. It was assumed that at the end of this year the reference rate would be 5,1% and only in 2026 would it drop to 4,2%. However, due to faster disinflation trends, the Monetary Policy Committee may assume that CPI will be close to the inflation target already at the end of this year, and by the end of 2025 it will fall below 2%. Such revisions will have far-reaching implications for the expected cycle of interest rate cuts, as the central bank will need to make faster and larger cuts to bring the benchmark rate to a less restrictive level. Conditional assumptions may therefore indicate that the reference rate will fall to a conservative level of 4,5% this year, to 4,2% in 2025 and below 4% in 2026. In this case, markets will increase expectations for a rate cut.

Currently, markets are taking into account a 110 bp rate cut by the end of the year, starting in May. Moderate economic forecasts are likely to accelerate the pace of growth in these expectations. As a result, the British yield curve will probably undergo the so-called bullish uplift and even greater "disinversion" (reversal).

The votes of the Monetary Policy Committee may signal an earlier easing of policy

At the BoE's December monetary policy meeting, three members of the Monetary Policy Committee voted to increase interest rates by a further 25 basis points, while the remaining six voted to keep the reference rate at 5,25%. Given the evidence of disinflation presented by the Committee, it is possible that its members will at this week's meeting will vote unanimously to keep interest rates unchanged for the first time since September 2021, departing from the central bank's current policy tightening. If one member votes to cut interest rates, it would be an early sign that rate cuts are back on the table, fueling speculation about a March cut. Whether such cuts would actually be made is irrelevant - it would be enough to trigger an immediate bond market rally.

Disinflation favors British government bonds

With disinflation trends accelerating around the world and central banks easing monetary policy, yield curves will find fertile ground for bullish growth, giving investors a reason to extend the duration of their bond portfolios. Ten-year UK Treasury yield may fall, testing support at 3,75%; breaking this level may result in a drop to December lows around 3,43%.

About the Author

Althea Spinozzi, Marketing Manager, Saxo Bank. She joined the group Saxo Bank in 2017. Althea conducts research on fixed income instruments and works directly with clients to help them select and trade bonds. Due to his expertise in leveraged debt, he focuses particularly on high yield and corporate bonds with an attractive risk-to-return ratio.