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Last week saw the announcement of a sharp drop in UK inflation, from a 2.7% year-on-year increase in September to a 2.2% year-on-year increase in October.  This has been driven by a stronger sterling, weaker commodity prices and only modest wage increases.  The Bank of England reduced its inflation forecast to 2.1% in 2014 and 1.9% in 2015.  In turn, this gives the Bank room to leave interest rates low for some time to encourage economic recovery, which is only now gaining momentum, with the Bank raising the 2014 growth forecast from 2.6% to 2.8%.

To prevent bond yields rising too quickly and choking recovery, the Bank’s Monetary Policy Committee stated that it would not consider raising rates until the UK unemployment rate has come down to 7%.  In August, the Committee forecast a 50% probability of this target being hit in mid 2016, but that has now been brought forward to mid 2015.  Our view is that this forward guidance is helpful, but subject to changing conditions, and all told interest rates are likely to begin to rise in mid 2015.