Markets too dovish in expecting no rate hike until 2017

Markets expectations for the timing of the first hike in UK interest rates have moved significantly over the past month or so. While global market uncertainty in August had meant that markets were already expecting the MPC to hold off from hiking rates until the end of 2016, the decision by the US FOMC to keep rates on hold in September saw markets push back their expectations for the first hike in UK interest rates all the way to Q1 2017. This dovish view was only reinforced by a weak set of US jobs figures for September, and a deterioration in the UK’s Markit/CIPS Services Survey. To our eyes, this looks like an overreaction. While economic growth appears to have slowed in Q3, we think it will regain pace soon. What’s more, we think that the US Fed will raise rates early in 2016. Nonetheless, with a revival in productivity set to keep a lid on unit wage costs, the MPC is under no pressure to raise rates soon. So we doubt the first hike will come before Q2 2016. And thereafter, rates are set to rise extremely slowly by past standards.