Bond Watch: UK rates hit 4.5% but bond investors watching US closely

Sam Benstead breaks down the latest news affecting bond investors.

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.

Bank of England raises rates again

Interest rates in the UK hit 4.5% this week, as the Bank of England implemented its 12th consecutive rate rise.

Expected by markets, there was limited movement in stock and bond prices following the decision.

Higher interest rates are set to feed into mortgage costs for millions of people. JP Morgan Asset Management says that by the end of 2023, 1.4 million people will be forced to remortgage at higher rates, with households typically having to pay 35% in monthly payments.

Mike Bell, global market strategist at JP Morgan Asset Management, said: “This will probably cause most of those households to cut back on their discretionary spending and hence dampen inflation pressures, while increasing the chance of there being a recession.”

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Bell reckons this will cause the Bank of England to stop raising interest rates, while it waits to see the impact on the economy.

“Personally, I think they should now pause. They can always hike rates further later on if needs be to get the job done but if they keep raising rates before the effect of their prior tightening has been felt, they risk going too far and doing more damage to the economy than is required to bring inflation back to target,” he said.

Nevertheless, the Bank of England said that the economic growth outlook had improved, which gives it more scope to raise interest rates.

Inflation falls below 5% in the US

Inflation in America slowed to below 5% for the first time in two years, with lower energy costs dragging down prices.

Inflation was 4.9% in the year to April, lower than the 5% forecast, prompting investors to bet that the Federal Reserve will now pause its interest rate rises.

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This boosted stock and bond markets, as the ever-closer prospect of interest rate cuts in America would be good news for investment valuations.

Despite the rapid rise of interest rates in America, the economy is in good shape. Jobs figures released last week showed that in April the US added 253,000 non-farm jobs and the unemployment rate was just 3.4%.

Could the US default on its debt?

While inflation is being tamed in America, and the economy is performing well, the worry is now that the US government could default on its debt if it does not lift its borrowing limit.

The debt ceiling, or debt limit, is a cap imposed by Congress on how much the US Treasury can borrow. Once the limit is reached, the government cannot increase its borrowing unless Congress agrees. The US has never defaulted on its debt but the consequences for financial markets could be catastrophic.

Treasury boss Janet Yellen warned that if the debt ceiling is not lifted, then the US risks running out of money by 1 June 2023.

There is currently a standoff in Congress between the Democrats and Republican, with the Republicans pushing for spending cuts as part of an agreement to increase the debt ceiling.

While extremely unlikely that the US will default on its debt, bond investors will be closely watching what happens.