Current pricing for Bank of England rate hikes will rapidly take UK real rates from being among the lowest in the world to being one of the highest, posing a significant risk to the economy.
The UK’s real rate, even after today’s larger-than-expected 50-bps rate rise, is still one of the most negative in the world, with only Sweden and Turkey having a lower real policy rate.
But the UK is projected to very quickly have one of the highest real policy rates, due to a combination of inflation that is expected to fall at a greater pace in the coming months (due mainly to base effects and to the energy price cap falling from July), and aggressive rate-hike expectations.
Within one year’s time, the UK’s real policy rate is anticipated to be just under 3%, higher than the 2.7% expected for the US, and well above the 0.7% projected for Europe.
This raises the question: how damaging will this be for the economy?
There had been tepid signs that weak growth in the UK was stabilizing, with, for instance, a nascent bounce in mortgage approvals and consumer confidence.
But yesterday’s hawkish move from the BOE has likely put an end to that.
As the chart below shows, over the last 10 years, there has been a close, inverse relationship between UK mortgage rates and consumer confidence.
Higher mortgage rates, especially as cumulatively more borrowers come off fixed-rate deals, threaten to progressively depress spending and increasingly corrode confidence in the housing market.
The rates market seems to be reflecting the increasing likelihood aggressive rate hikes will lead to an economic fallout that will necessitate cuts down the road. While the front SONIA futures have sold off ~20 bps, the red and green contracts expiring in 2024 and 2025 are rallying.
BOE Governor Andrew Bailey said yesterday the economy was doing better than expected, but if the bank follows through on rate expectations, it may end up doing much worse than they feared.
