Markets Brace for U.K. Rate Rise

By Mike Bird Features Dow Jones Newswires

The Bank of England is expected to raise interest rates for the first time in a decade Thursday, with investors trying to weigh up what that means across different markets.

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What the nine-member monetary policy committee says about the future of interest rates could move markets sharply, even if the central bank does what's expected, like the European Central Bank did earlier in October.

"We could see quite big swings [in markets] this week depending on how they communicate the rate hike," said Kacper Brzezniak, U.K. fixed income portfolio manager at Allianz Global Investors. "You've already got a lot of uncertainty about what comes next."

The overnight index swap curve--a key measure of future interest rate expectations--has risen to account for the higher rates predicted. However, it is only pricing in one more rate hike in the next five years than it was on Sept. 13, immediately before the BOE hinted that a rate rise would come soon.

Investors are split over what guidance the bank will offer on the future path of policy.

"We're not in the 'one and done' camp," said Paul Rayner, head of government bonds at Royal London Asset Management. "We think it'd be very odd if we don't see a hike on Thursday, followed by some sort of signal that they'd be happy pricing another rate by the end of next year."

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Since the U.K's June 2016 vote to leave the European Union, the currency market has borne the brunt of shifting expectations for interest rates and political developments.

Roughly as many speculators are now betting on a fall in the pound as a rise, according to data from the U.S. Commodity Futures Trading Commission. As recently as April, there were over 100,000 more long than short speculative contracts on sterling--meaning more bearish bets on the currency.

If the U.K. central bank surprises markets by holding rates at current levels, some analysts believe positioning could shift back, causing sterling to decline sharply again.

BNP Paribas analysts expect the bank won't raise interest rates Thursday and forecast the pound will fall back to around $1.25 by the end of March 2018.

U.K. government bonds, or gilts, are also priced for a hike. Two-year yields climbed sharply in September, back to similar levels recorded just before the EU referendum. Even so, some analysts think gilts are expensive based on risks to the U.K.'s economy.

Analysts at Barclays regard U.K. government bonds as more overpriced than any other European market, citing the possibility of a disorderly British exit from the EU.

U.K. equities have largely followed sterling since the EU referendum. FTSE 100 companies make less than a third of their total revenues in the U.K, according to data provider FactSet.

That means that when the British pound sells off, the share prices of the companies--denominated in sterling--are prone to rise.

However, some analysts say another sterling tumble wouldn't be positive for U.K. equities.

"Weaker sterling will likely fail to support U.K. equities in the period ahead," said Yianos Kontopoulos, global head of macro strategy at UBS, citing a tipping point at which depreciation causes higher inflation and further rate increases and stops benefiting the FTSE 100.

"Too much cumulative depreciation raises uncertainty," he added.

Write to Mike Bird at Mike.Bird@wsj.com

(END) Dow Jones Newswires

October 31, 2017 08:46 ET (12:46 GMT)