- Central banks face a tough task – they don’t want to keep rates too high for too long as this will likely cause a recession.
- Bonds have already benefited from the expectation that rates will be cut.
- Bond prices continue to increase, with yields falling, if additional rate cuts are confirmed.
Hal Cook, senior investment analyst, Hargreaves Lansdown:
“With inflation falling throughout the first half of 2024, the ECB and BoE felt confident enough to start reducing interest rates. Both implemented a 0.25% cut. Good news for anyone looking to borrow, whether that’s individuals trying to remortgage or buy a house or car, or companies looking to borrow to invest or refinance current debts.
Let’s not get too carried away though. These are small cuts. And they were anticipated – if anything, they took longer to arrive than most expected. The ECB also held rates at their meeting in July, highlighting that we aren’t now in a race to the bottom with respect to interest rates. Central banks face a tough task. They think that inflation will likely increase again in 2024. So they need to be careful that any increase from here is short lived because no one wants inflation back into double figures again. At the same time, they don’t want to keep rates too high for too long as this will likely cause a recession. This means that lots of small cuts, or a few big cuts, are unlikely at this stage. But also, the potential for no cuts, or even rises, is unlikely too.
Bond prices usually move in the opposite direction to interest rates. This is because if interest rates increase, it makes bonds less appealing relative to investing in cash. So, people sell bonds, reducing demand, and their prices fall.
As prices fall, bond yields increase. This is what happened in bond markets throughout most of 2022 and some of 2023 as central banks went through their rate hiking cycle. The result was that bond investors experienced large losses. Coming back to rate cuts, the hope is that this will mean the opposite: bonds will increase in value and yields will fall.
However, it’s important to remember that markets move early, anticipating what will happen in future. While interest rates had been held steady since August 2023 in the UK, the yield on the 10-year UK Gilt had moved down, from around 4.6% mid-way through 2023 to 4% at the end of July 2024, just ahead of the decision by the BoE to cut rates. In other words, bonds have already benefited from the expectation that rates will be cut.
Looking forward from here, it’s more likely that there will be additional rate cuts as opposed to rises. Which means bond prices could continue to increase, with yields falling. The market thinks Bank of England base rate will be 50bps lower by the end of 2024. But of course, there are no guarantees.
