Bond Watch: investors dial up bets on UK rate cuts

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.      

• Invest with ii: Investing in Bonds | Free Regular Investing | Open a SIPP

Here’s what you need to know this week. 

UK inflation lands cooler than expected 

The UK consumer price index (CPI) rose 4% in the 12 months to January 2024, lower than forecasted, which boosts the case for Bank of England interest rate cuts this year.  

UK GDP for the final three months of 2024 was also released this week, showing that the economy officially entered recession last year. The final quarter of the year saw a 0.3% contraction, which followed a 0.1% decline in the third quarter of the year. Two quarters of consecutive GDP contraction is deemed a recession by economists.  

Slowing inflation and a weakening economy give the central bank more scope to cut interest rates to stimulate growth without fears that inflation will spike too much.  

The Financial Times reported that traders now expect a 65% probability of a 0.25 point interest rate cut in June, up from a 40% likelihood before the data was released.  

Deutsche Bank expects CPI to average 2.3% this year in the UK, before dropping 1.9% in 2025. 

• Benstead on Bonds: these pros have seen it all. Here’s what they’re buying today
• How stocks, bonds, and cash perform when interest rates fall

On rate cuts, it says: “While it’s still too difficult to call, we think rate cuts could start as early as May 2023 – our long-standing base case.” 

Dickie Hodges, manager of the Nomura Dynamic Bond fund, says that UK interest rates could settle somewhere between 3% and 3.5%, but interest rate cuts would likely follow what the US Federal Reserve decides to do. He also says there will be a pause in rate cuts around general elections later this year in the US and UK. 

But US inflation comes in hot... 

While UK prices fell more than expected, US inflation was above expectations in January. US consumer prices rose 3.1% on an annualised basis, down from 3.4% in December, but ahead of the 2.9% forecast.  

This hot reading caused stock and bond markets to fall, as investors dialled back bets on interest rate cuts in the US.  

Following the new data, markets implied a 30% chance of an interest rate cut in May, down from a 50% likelihood.  

• Bond Watch: why higher inflation didn’t spook bond markets
• Rathbone Ethical Bond:A 5% income yield makes bonds an insurance policy

Greg Wilensky, head of US fixed income at Janus Henderson Investors, said: “CPI data came in stronger than either the Federal Reserve or the market wanted or expected.   

“With this new data, a first cut in June seems like the most reasonable expectation unless we see a very quick, severe drop in the labour market activity or a geopolitical shock.”