Interactive Investor

Bond Watch: why UK interest rates could hit 6.5%

7th July 2023 09:02

by Sam Benstead from interactive investor

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Sam Benstead breaks down the latest news affecting bond investors.

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Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

Here’s what you need to know this week.

More pain to come for UK households

Bloomberg reported that the bond market is now pricing in UK interest rates to peak at 6.5% by March, as the Bank of England struggles to take control of inflation.

Inflation for May came in at 8.7%, unchanged from April, with core inflation (which excludes energy, food, alcohol and tobacco) rising from 6.8% to 7.1%.

Schroders, the fund manager, reckons the Bank of England will raise rates by 50 basis points in August and September, before slowing to 25 point increments in November and December. It now anticipates 6.5% rates by the end of 2023.

Azad Zangana, a senior economist at Schroders, says the Bank of England is no longer able to wait and see how the interest rate rises so far will affect the economy.

“We know that interest rates work with long and variable lags, and it is not exactly clear yet what the effect of the 13 consecutive rate rises seen so far will be.

“With its forecasting abilities under question, however, the Bank of England’s likely approach now comes with a risk of ‘policy error’ where it raises interest rates too high.

“Perhaps more than any other developed economy central bank, the Bank of England is set on a course of prioritising inflation over growth. And it’s becoming increasingly clear that the trade-off for taming inflation will likely be a recession.”

The Organisation for Economic Co-operation and Development (OECD) says the UK is now the only G7 country that is still dealing with rising inflation, with its figures showing prices rose 7.9% in May, up from 7.8% in April.

Debt issued at highest average yield since 2007

It’s not just households that are feeling the pinch from higher interest rates, but the UK government too.

It issued bonds (gilts) at their highest average yield since 2007 this week. It committed to paying investors 5.7% to borrow for just over two years and in total it raised £4 billion.

A bond issued at the start of the year, also maturing in October 2025, cost the government 3.6% a year, showing how borrowing costs have risen sharply this year.

The Bank of England has raised interest rates 13 times in a row since towards the end of 2021, taking them from 0.1% to 5% today.

The UK government is planning to sell £241 billion of bonds for the 2023-24 fiscal year, the highest annual bill ever apart from the £486 billion sold during the 2020 to 2021 pandemic period.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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