M&G head of retail fixed interest Jim Leaviss has warned that the Bank of England could make a policy error by hiking interest rates in the near future.
Leaviss believes we may be seeing a re-run of the 1993/94 economic scenario, when bonds rallied hard in 1993 before the Fed unexpectedly hiked rates in February 1994, resulting in a 200bps sell off in 10 year Treasury yields.
He says while the Fed may wait for unemployment to fall further from its current level of 9 per cent, as it has in the past two cycles, the inflation concerns in the UK are more pressing given that the BoE has continually missed its 2 per cent target, pointing to the fact that it has actually been above 3 per cent for most of 2010.
Leaviss points to RPI inflation standing at 4.7 per cent, while the 2.5 per cent VAT hike is set to feed into markets.
He says the money markets are already pricing in two 0.25 per cent rate hikes in the UK this year, with a small chance that there will be a third rate hike by year end.
Leaviss says: “Rate hikes would kill core inflation but they would also be GDP-suicide in this fragile economy, bringing deflation risks back into play. Hopefully the Bank still feels it can target future inflation, and has the confidence to ignore those reacting to current inflation newsflow and calling for imminent rate hikes. But I don’t think that the Bank of England has much breathing room left, and with persistently high current inflation the Bank’s credibility is under attack. I think we’re only one surprisingly robust inflation print away from a UK rate hike.”