It added that keeping rates higher for too long, until there is evidence of disinflation, is risky. “The historical lesson since the 1970s has been not to cut rates until one is sure the inflationary risks have been contained. But a higher level of indebtedness means the policy trade-offs are now harder to navigate, and the balance of risks is more two-sided.”
BoE deputy governor for monetary policy Ben Broadbent was recently quoted in the Financial Times as saying uncertainty over the state of the UK’s labour market would force the central bank to wait longer before it can cut interest rates.
Financial markets are currently pricing in about 1.15 percentage points of cuts by December next year, the report stated.
Unpredictable markets
Monetary policy shifts across the globe drove market returns in 2023, while geopolitical uncertainty certainty ensured volatility was high throughout the year.
A combination of higher base rates and sharply revised expectations around the future direction of monetary policy caused long-duration equity and bonds to suffer sharp price falls at the start of 2023, while the final quarter was marked by investors believing rates have peaked and so provoking a rally in risk assets.
As Mazars Wealth Management chief economist George Lagarias writes in a recent report on FT Adviser: “It is difficult to forecast what 2024 will look like… Simply put, given the stock and bond market volatility, we do not know what the starting point for equity valuations and rates will be in the next 30 days.”
Stocks and bonds were nearly flat by the end of October and were up 10 per cent and 5 per cent, respectively, 30 days later. “That is volatility,” he writes.
Added to that was uncertainty with two major wars still waging in eastern Europe and the Middle East.
Lagarias expects equity markets to continue to range-trade, perhaps with a “slight upward tilt”, as they are being constrained by quantitative tightening but bolstered by conditions that “are not dire enough to initiate a bear market”.
He also expects rate cuts to begin later in the year. When rate cuts begin, he expects short rates to come down faster than long rates, allowing the yield curve to bull steepen. This means the whole curve comes down, but faster at the shorter end.
But Lagarias adds that there is the possibility of bear steepening (when the curve moves up faster at the longer end) in case a financial accident forces central banks to cut rates.
