On 4th November, the Bank of England (BOE) announced that its base interest rate will remain at 0.1%. This was a surprise to investors as policymakers had made statements that suggested a contractionary monetary policy would be adopted instead. The impact of the Bank of England’s decision was noticeable in bond markets both domestically and internationally.
In recent weeks, global bond markets have been detrimentally affected by the expectations of a rise in interest rates. This belief was contingent upon the concerns about inflationary pressures affecting the global economy. However, the consensus appears to be that inflation is currently being driven by commodity prices and supply-chain issues such as ‘a logjam of shipping containers’ at the Port of Felixstowe, Britain’s largest container port, as reported by the BBC. In theory, when the government stimulus reduces, there will be less need for a long-term monetary policy change.
After the Bank of England’s announcement, there has been a notable difference in UK Bond yields, specifically the benchmark one-year gilt yield that dropped 0.22%. There was also depreciation of the Pound (GBP) 1.4% against the dollar as a result. Due to market expectations of an interest rate rise, investors sold government bonds, causing prices to drop and yields to rise. However, the benchmark 10-year bond yield fell 0.98% on Thursday (post-decision). The reason for this effect was that interest rates affect bond yields and higher bond prices. The UK government debt thus rallied its loss from recent weeks.
Furthermore, the Bank of England’s decision also similarly impacted foreign bond markets. Yields on US two-year Treasury fell 0.07% to 0.41%. The German one-year government yields fell 0.08% to negative 0.83%. Especially in the US, the impact of the central bank’s decision is compounded by its timing. The Federal Reserve confirmed its intention to reduce its bond purchases by 15 billion USD a month. The trajectory after such a decision was expected to continue across the pond so US debt prices also jumped after the decision.
Overall, the implications of the BOE’s decision are positive, specifically for the UK bond market. A lower base rate leads to greater demand in the economy and rising bond prices. Although this is a relief to investors in the short term, the likelihood of an abrupt change in the base rate is greater since the BOE voted against a premature end of the asset-purchase programme, which could have mitigated the inflationary pressures.
Other parts of the central bank’s policy affect the impact of the base rate decision. As it stands the asset-purchase programme acts as an expansionary monetary policy. The BOE buys government bonds and thus increases the money supply in the economy. This intended to increase prices and lower interest rates. However, the concern about inflation is real. Annual inflation is expected to peak at 4.8% in 2022, according to forecasts by the central bank. This is double the BOE’s two percent goal. A large factor affecting the bond markets is inflation, so although bond yields would fall in the short-term due to the base rate. In the long-run, inflation would lower the real yield of the bond. This calls into question the efficacy of the BOE’s decision.
Assuming the lack of impact on inflation to be of detriment to the decision, whether inflation could be changed simultaneously at all by the BOE is important. One could argue that inflation would not be productively impacted by an end to the asset-purchase programme. Instead, the government could tackle the systemic issues that are present in the recurring bouts in high inflation. The labour shortages and supply chain issues will eventually improve however the UK is continually dependent on volatile commodity prices. The UK economy’s dependence on imported food, energy and other commodities deems it vulnerable to fluctuations in price. However, this spike in inflation can be seen as cyclical and will resolve itself largely when labour shortages and supply chain issues are addressed.
Ultimately, the Bank of England’s base rate decision has had a positive impact on domestic and international bond markets. It is indeed positive that losses have been recuperated in government debt. However, the extent of the impact of the decision is contingent upon certain factors, such as the government stimulus. If the inflation corrects itself and the labour shortages, supply chain issues and volatile commodity prices decrease then the bond yields will have a greater real value. If that is not the case, this decision is simply prolonging an issue and putting pressure on the central bank to make a more abrupt change later.
By Hannah Duale
Sector Head: Sophia Li