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Swap rates dip on back of MPC rate decision – Maddox

by: Alex Maddox, product and capital markets director at The Northview Group
  • 04/06/2018
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Swap rates dip on back of MPC rate decision – Maddox
Against market expectations earlier in the year, the Bank of England held the base rate at 0.5% in May as the bank adopted a “wait and see” approach.

 

Despite markets long anticipating a May rate rise, the Bank of England’s Monetary Policy Committee (MPC) preferred to delay this increase until later in the year.

Weak economic data released shortly before May’s meeting caused the committee to vote in favour of keeping the base rate at 0.5%.

GDP figures showed that in the first quarter of 2018 the UK grew at its slowest rate in five years – growing only at +0.1%.

This slow growth in the early part of the year prompted the Bank of England to revise down its growth prediction for 2018 from 1.8% to 1.4%.

 

Inflation dipping

Despite the weak growth, the vote to keep the base rate at 0.5% was not unanimous.

Both Ian McCafferty and Michael Saunders were in favour of raising the rate to 0.75% – they were also the two members voting for a rate rise at the previous meeting.

Inflation appears to be coming under control as the central bank lowered its forecasts for both the short and medium term.

With inflation dropping to 2.5% in March (the lowest level since the beginning of the year) and the unemployment rate also lower, the Bank of England now expects inflation to reach 2.2% by the end of 2018 and to return to its 2% target within the next two years.

UK wage growth finally rose above inflation at +2.8% in the period between December and February.

 

Swap rates fall

Looking forward, the Bank of England said that the next rate rise would take place when there will be greater certainty on the UK’s negotiations with the European Union and stronger economic growth.

The market’s view is that will be at the end of this year since the expectation for the next rate rise is now the fourth quarter of 2018.

The two-year swap rate fell immediately following the MPC meeting, with trades now taking place around the 1% mark.

This is 5bps lower than just before the vote and well down on the 2018 peak – of 1.17% – which was recorded in the middle of April.

However, this is still well above December, when swap rates were trading around 75bps, following the raising of the base rate from 0.25% to 0.5%.

 

Rise within six months

Due to the unexpected decision to delay the base rate rise due to weak economic growth, the market now expects the next base rate rise of 0.25% will take place within the next six months.

The market expects the base rate to reach 1% within two years before rising to 1.25% in the following 12 months.

In the LIBOR (London Inter-Bank Ordinary Rate) market, predictions for the short-term remain the same, as LIBOR is expected to reach 0.75% in the next month and to hit 1% by the summer. However, looking 12 months ahead, the market anticipates LIBOR to be at the 1% mark, lower than the previous 1.25% prediction.

In the swap markets, the market expects the two-year swap rate to remain at 1% throughout the summer before rising to 1.25% at the turn of the year.

Five-year swap rates will remain at 1.25% for at least a year while 10-year fixed swaps are expected to be at the 1.5% mark for at least two years.

 

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