We think the moves are unjustified, though, and have been adding duration into the portfolios on the back of this.
The transparent, calm and frankly dull BoE meetings we had become accustomed to over the last 12 months gave way to one of surprise in the latest September meeting.
On the face of it, little changed, with interest rates kept at record lows and quantitative easing (QE) set to continue, despite two hawkish members dissenting against this.
The key surprise, and what has led to a bout of volatility in gilt markets, came from talk that rate rises are being considered before the conclusion of QE. While we had been marginally underweight duration coming into this meeting, this notion caught us and many market participants off-guard.
It was only a month ago at the August meeting that the BoE had laid out a clear path for QE and monetary policy normalisation in an effort to be transparent with the market, and hopefully allowing for a careful and orderly transition. Clearly, within the space of a month, that transparency has been thrown out of the window, which is disappointing for any central bank.
The journey to unwinding the exceptionally loose monetary policy stance adopted since March 2020 needs to be handled with clarity, not confusion.
What has changed?
In fairness to the BoE’s mandate, their focus is on inflation rather than a dual mandate that incorporates growth as well, and this has made the last few months challenging. With their view that inflation will remain above 4% and with ongoing supply and labour issues that are unlikely to be resolved anytime soon, one can understand their hawkishness (we are now in ‘letter-writing’ territory after all!).
However, therein lies the risk with the current policy stance, if this is in response to the inflation data which proves to be transitory, then the BoE could be tightening policy at a time when the demand side of the economy is losing momentum; monthly GDP data is tracking below the BoE’s projections, retail sales continue to disappoint, and the energy/utility spike will only prove to be a drag on consumer spending.
Furthermore, looking into 2022, while growth will be above pre-Covid levels, major headwinds persist in the form of the furlough scheme ending and the largest tax rises in 40 years. And these are all domestic risks, add in the risk of Covid-19 variants and the impending slowdown in China and the growth headwinds become even more pronounced!
As a result of the latest meeting, gilt yields rose sharply and market expectations for rate hikes were brought forward. The market now expects a first hike of 15 basis points (bps) from 0.1% to 0.25% in March 2022 (from May 2022) with a further hike to 0.5% now priced for August 2022. We think the market reaction is overdone and the BoE will struggle to go through with its latest normalisation framework. The headwinds to growth are simply too great and debt loads too high and, as a result, we have been adding sterling duration to the portfolios.
A key risk for all asset markets in 2022 is central bank policy error and the BoE seem to be have taken the first step to claiming that unwanted tag.
Sajiv Vaid is portfolio manager at Fidelity International
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