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UK money markets signal near certainty of rate rise

UK money markets signal near certainty of rate rise

Sonia gyrations underline Carney’s struggle to steer expectations for monetary policy

UK short-term money markets were on Thursday signalling an interest rate rise by March as a near certainty, after two days of heavy trading when Bank of England governor Mark Carney has struggled to steer expectations for monetary policy.

It is the latest sign of shifting assumptions for monetary policy around the world with markets beginning to prepare for a co-ordinated reduction in extreme stimulus measures by several of the world’s central banks.

The Sterling Overnight Index Average, or Sonia rate — a measure of the price at which banks and building societies lend to each other — implies a 75 per cent chance that UK base rates will rise this year, according to Bank of America Merrill Lynch.

The policy-sensitive two-year gilt yield has risen above 0.3 per cent, back to a level seen in October, and buoyed the pound.

The swift change in expectations comes after a series of decisions and speeches by policymakers have revealed a more hawkish bent than was known just weeks ago, suggesting some of the accommodation introduced following the UK vote to leave the EU last year may be removed in the coming months.

The Bank of England’s rate-setting committee has become sharply split over whether to raise rates, having voted narrowly five to three this month to keep rates near historic lows.

Mr Carney and the BoE’s chief economist, Andy Haldane, publicly split over the way forward last week when Mr Haldane gave a speech suggesting rates should rise just a day after Mr Carney had signalled the opposite.

Mark Capleton, head of UK rates research for BofA ML, said the change from June 14 had been dramatic. “The market has gone from almost no chance of a hike priced in to that of a full hike priced in by March.”

Much of the move came after Mr Carney spoke at an ECB conference in Portugal on Wednesday, remarks which included the phrase that “some removal of monetary stimulus is likely to become necessary”.

Some remain unconvinced by the sharp move in money markets.

Jamie Searle, interest rate strategist for the bank, said Mr Carney’s speech indicated tightening could be necessary only if certain conditions were met. “We are still not convinced that a hike will be forthcoming,” he said.

The Sonia rate is favoured by the BoE as a replacement for the London Interbank Offer Rate, or Libor benchmark, which was manipulated by traders during the financial crisis.

Policymakers use the prices implied by the Sonia market as part of their calculations for estimating the future path of interest rates and inflation.

On Tuesday, the overnight Sonia rate was 0.21 per cent, a usual 4 basis point discount below the UK policy rate. The forward rate for March 2018 was trading around 0.45 per cent.

Other indications of the implied chances of a November hike suggested less chance of a move.

A Bloomberg calculation of the probability implied by option prices on Thursday suggested that there is a two-in-three chance that interest rates will be higher by March.

 

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