Bond Watch: interest rates appear to have finally peaked

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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Here’s what you need to know this week.  

Another hold from the Bank of England 

The Bank of England (BoE) kept rates unchanged at 5.25% for the second month in a row, and indicated to investors that interest rates have likely peaked but could stay high for some time.  

Holding interest rates where they are suggests that Bank governor Andrew Bailey believes that monetary policy is restrictive enough to finally bring inflation back to its 2% target over the medium term.  

However, some analysts now expect to see rate cuts before summer 2024, with Deutsche Bank strategist Jim Reid saying that their internal forecasts for inflation are lower than the BoE’s. 

He said: “And with the Bank of England's inflation and wage projections sitting higher than our own forecasts for the coming months, should successive misses emerge [in the Banks' economic forecasts], this could give the Monetary Policy Committee enough confidence to adjust its policy settings to a slightly less restrictive level.” 

• The bond funds making money despite the fixed-income crash
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• Interest rates held again: prepare your portfolio for the next phase

Bonds and stocks have rallied this week, with the FTSE 100 rising around 2% and the 10-year gilt yield dropping from 4.6% to 4.4%.  

Bond prices are extremely sensitive to interest rate changes, and importantly, expectations about where interest rates will be in the future. Gilt yields fell, which is a result of bond prices rising, in the run-up to the rate decision, as investors bet that the BoE would follow the Federal Reserve in America and pause rate rises.   

And the Federal Reserve also hit pause 

In a busy week for central bank news, the US Federal Reserve also decided to keep interest rates at the same level for the second time in a row, reinforcing perceptions around the world that the major central banks have finally got interest rates to a level where they will bring down inflation – hopefully without causing a recession. The European Central Bank also paused its rate-rising cycle last week.  

After many false dawns, where bond investors predicted the end of rate rises and the beginning of rate cuts, it appears that we are finally into the next stage in the fight against inflation and the key question is now when interest rates will fall.  

Falling interest rates, or a consensus that they are set to fall, would likely be good news for stock and bond prices. 

• Don’t expect UK interest rates to fall in 2024
• Bond Watch: what ‘higher for longer’ rates mean for bond prices

But whereas stocks may respond negatively to a weak economy, the safest bonds, such as UK or US government debt, would likely rise in value if investors are seeking defensive assets.  

Neil Birrell, chief investment officer at Premier Miton Investors, commented: “With the US economy remaining strong and inflation proving sticky, the Federal Reserve has chosen to leave rates on hold for a second successive meeting.  

“The language used in the statement is interesting, with the Federal Reserve noting that they do expect tighter financial conditions to slow the economy. The read-across from that must be that they expect inflation to dampen as well. There can be no doubt that they stand ready to act if needed, however it does seem that ‘so far so good’ is the outcome of their policy measures for now.”