Bond Watch: interest rates held at 4.75%

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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No rate cut from the Bank of England...

As expected, the UK central bank left interest rates unchanged at 4.75%, with the Monetary Policy Committee voting six-to-three in favour of the decision. Three voted for a rate cut.

Inflation has been rising steadily in the UK, hitting 2.3% in October and 2.6% in November. This has made the Bank of England more reluctant to cut rates and stimulate the economy. Gilt markets were stable after the news, but yields have been rising over the past two months.

The 10-year gilt now yields 4.6%, up from 3.8% in mid-September. Gilt yields rise when bond prices fall, meaning that gilt investors have seen their capital value decline over the past couple of months. However, new investors can lock in a higher return.

Rising inflation and non-existent economic growth is hurting bond markets.

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Vivek Paul, UK chief investment strategist, fund group BlackRock, said: “The Bank of England faces a particularly challenging mix of persistent inflation and slower growth - and is forecasting the UK economy to have stood still in Q4.

“The government’s first Budget in October highlighted this dynamic: its attempts to boost growth also pushed up inflation expectations, per the Office for Budget Responsibility’s forecasts.”

BlackRock expects the Bank of England to keep cutting cautiously in 2025, and beyond that, for interest rates to settle at around 3%.

“That’s why we remain overweight UK gilts across maturities on both a tactical and strategic horizon,” Paul said.

Deutsche Bank now expects four interest rate cuts in 2025, with only one coming in the first half of the year.

...but the Federal Reserve eases policy

While the Bank of England held rates steady this month, its US counterpart cut interest rates by 25 basis points to a range of 4.25-4.5%.

Despite the cut, chair Jerome Powell issued a “hawkish” statement signalling a slower pace of cuts next year due to a booming US economy. He indicated that there could just be two cuts next year in the US.

In response, stocks and bonds fell. Falling bond prices pushed up yields in the US but also around the world. 

Matthew Morgan, head of fixed income at Jupiter Asset Management, said: “Another rate cut was completely expected given that the Fed is still in a rate-cutting cycle and believes current policy to be restrictive. As it stands, the market expects only two further cuts in the whole of 2025.”

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The strength of the US economy means that rates may not need to fall much further. Morgan says that the hawkish comments from the US Federal Reserve were not surprising given consumer spending, policy uncertainty (particularly around tariffs) and jobs looking in decent health.

“However, we think we are likely to see rate cut expectations increase next year as growth softens. The labour market is clearly cooling, inflation is softening, and Europe and China are a drag on global growth,” he adds.