UK: 10-year gilt yields to resume their rise – Lloyds Bank

According to the research team at Lloyds Bank, global factors are likely to pull UK term rates higher and they expect 10-year gilt yields to resume their rise.

Key Quotes

“From a year-to-date low of 1.08% on 24 February, 10-year UK gilt yields recovered to 1.25% by 21 March, before fading back to 1.08% by 10 April. The round trip left the gap between US Treasury and UK gilt yields little changed over the period, at around 130bp. A move upwards in US yields during 2017 as the FOMC continues to tighten policy remains our central view, supported by the residual expectation of a Trump-led fiscal boost. A shallower rise in UK term rates vis-à-vis the US seems justifiable by the expected underperformance of UK economic growth in 2017, along with perceptions that the Bank of England is in no hurry to tighten its monetary policy stance. That lack of enthusiasm to tighten comes despite a surge of UK inflation, which burst through the BoE’s 2% CPI target in February to hit 2.3%y/y and held there in March, its highest since September 2013.”

“To be sure, the risk of a quicker pace of tightening from the Federal Reserve remains alive despite questions around the US administration’s ability to deliver looser fiscal policy. But while the Fed’s ‘dot plot’ envisages two further hikes in the course of 2017 – alongside a reduction in the size of the Fed’s balance sheet being flagged in the March FOMC minutes – the direct read across to the UK monetary policy outlook remains limited. Market expectations currently put a 50% probability on a Bank of England policy rate hike by 2018 Q4, with risks relative to market pricing in both directions.”

“On the one hand, ongoing economic resilience would test the willingness of some on the MPC to tolerate above-target inflation. Economic growth in 2017 Q1 now seems likely to slow from the above-trend pace seen in the second half of 2016, though could still trump the BoE’s expectations. Conversely, the MPC will also remain highly attuned to emerging signs of consumer weakness as sterling’s post-referendum drop saps purchasing power. With Kristin Forbes already preferring a tighter policy stance at the March MPC meeting, pressure for a Bank Rate hike could mount further over the coming months. Still, evidence that wage growth remains muted – dipping to just 2.2% in the 3 months to January and so painting a relatively benign picture for domestically-generated inflation – is salving the appetite for a tighter policy among the majority of the MPC.”

“In our view, the additional uncertainties surrounding the UK’s planned EU exit render unlikely a tightening in the immediate run-up to – and the aftermath of – the exit date. Given these downside risks and the prospect of tighter global financial conditions from higher term rates, we see no change in Bank Rate even as inflation rises. Global factors are likely to pull term rates higher and we expect 10-year gilt yields to resume their rise, reaching 1.5% by end-2017 and 2.2% by end-2018.”