Short-term UK rates rose on Tuesday after surprisingly strong services data but doubts over the sustainability of growth mean markets may be pricing in too much in terms of interest rate hikes. The Bank of England looks set to leave interest rates at a record low 0.5 percent this Thursday as weak domestic demand makes it reluctant to respond to what it hopes will be a temporary rise in inflation.
Only one of 67 economists polled by Reuters expects the BoE to raise rates, and the majority reckon the start in earnest of government fiscal tightening means UK rates will not rise until May at the earliest, and probably not until August. That compares with market pricing which shows a first rise anticipated in July, with a second around October.
Markets are pricing in just a 13 percent chance the BoE will hike rates this month, although that climbs to around a 70 percent chance of a rate increase in May. Nomura strategist Sean Maloney said the interest rate path through 2012 and 2013 had shifted up compared with a week ago, reflecting slightly stronger-than-expected economic data in the UK as well as more positive risk sentiment globally.
British service sector activity jumped in March to show its fastest pace of growth in over a year, pointing towards a 0.8 percent expansion for the economy as a whole in the first three months of 2011. And there may still not be enough priced in. "To reassert credibility and to reflect the evolution of the appropriate degree of accommodation, the MPC has to start hiking in May and has to continue raising rates by 25 bps per quarter," taking its benchmark rate to 1.25 percent by the end of this year and 2.25 percent by-end-2012, Moloney said in a note.
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