Bond Watch: Europe cuts rates – will the UK follow?

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.      

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.           

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What will the Bank of England do next week? 

The Bank of England Monetary Policy Committee (MPC) meets on Thursday next week (19 December) to set interest rates.  

According to Reuters, there is only a one in 10 chance of the Bank cutting rates from their 4.75% level today.  

Inflation rose in October to 2.3% compared with a 1.7% rise in September. The Bank thinks inflation should stay under 3% next year, but drop to near 2% in 2026, and then below 2% in 2027.  

At its last meeting, the MPC members said: “Based on the evolving evidence, a gradual approach to removing policy restraint remains appropriate. Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further.” 

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Nevertheless, Andrew Bailey, who leads the MPC, thinks that there will be four interest rate cuts in 2025, taking the base rate down to 3.75%. Therefore despite the Bank decision next week, it seems clear that interest rates are moving in a downwards direction. 

Harry Richards, manager of Jupiter Strategic Bond I Acc fund, thinks that investors are overestimating the health of the UK economy, and inflation and economic growth will slow more than expected. This therefore supports the view that interest rates could come down harder and faster than markets expect, which would boost bond prices. 

Richards’ view is supported by GDP numbers for October, showing that the economy contracted 0.1%, a second monthly drop in a row. This means growth has been worse than expected for three of the past four months, according to Deutsche Bank. 

Chief UK economist at Deutsche Bank Sanjay Raja added: “There’s probably more bad news on the horizon. Survey data paint a more pessimistic picture for Q4 2024 than the Office for Budget Responsibility and Bank of England’s growth models suggest. Budget uncertainty has hit demand and sentiment.” 

Europe cuts rates 

The European Central Bank this week cut rates from 3.25% to 3%. Inflation in the European Union for the year to November was 2.3%, up from 2% in October.  

Europe is battling slowing economies and the prospect of tariffs from the US when Donald Trump takes office.  

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Konstantin Veit, portfolio manager at PIMCO, says interest rates in Europe could settle at 1.75%. 

This could be a full two percentage points lower than interest rates in the UK, even though inflation is at a similar level. 

This gap shows the relative appeal of sterling bonds, as investors are getting paid a higher rate and a greater “real” or inflation-adjusted return too.