The UK's central bank has displayed stunning incompetence. The rate hike today was more or less largely priced in for over a month. Indeed, the forward curve for Sterling OIS has shifted up markedly. In short, forty-five days ago, the markets were expecting 1-2 rate hikes over the next 12 months. As of yesterday, markets were penciling in about 2-3.
Today, the Bank of England followed through on its expected rate hike, while inexplicably take future rate hikes off the table. In other words, the bank has issued dovish forward guidance while simultaneously hiking rates.
So now, the market is pricing in no more hikes. This a much more shallow path for rates than the previous consensus view. So UK yields have plummeted, with both the 10 and 2 year notes shedding seven basis points. And Sterling got whacked, down about 1.5 percent against the US dollar.
Today's move makes no sense whatsoever. The Bank of England has shifted from a tightening bias to a neutral-easing bias, and the markets have responded exactly how one would expect. Basic financial theory says that long rates are determined by the expected geometric average of short rates, and the Bank just caused markets shift down their expectation for future UK policy rates. And the same time, the Bank of England said in its statement it was hiking to help control inflation caused by the fall in sterling. Instead, it managed to tank the GBP and gilt yields. It is not at all clear to me if this was on purpose or not. It would certainly contradict the tone of the MPC's statement, but at the same time committee members must surely understand basic theories of the term structure. It makes no sense, I don't get it. I have no idea what the MPC was trying to accomplish. Maybe I should send my resume to Theresa May.
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