Banking 101 -

Can you predict interest rates?

Interest rates play a vital role in the economy; they influence the rate of borrowing, saving, investment, and spending. Understanding interest rate movements is a valuable tool, but can anybody predict interest rates accurately?

The setting of interest rates and control of the money supply both fall under ‘monetary policy’. Monetary policy is generally set and managed by central banks around the world; the Federal Reserve (Fed) in the US and the Bank of England (BoE) in the UK.

Central banks set the short-term interest rate – known as the base rate – for their domestic economy as a tool to manage inflation to a long-term target (2% here in the UK) and/or stimulate economic growth. The BoE reviews and votes on rates eight times a year. These short-term base rates influence the rates offered by banks, affecting the longer-term cost of money, such as mortgage and deposit rates.


Central banks and interest rates

Various factors will influence a central bank’s decision on interest rates, which can make predicting what might come next challenging. The BoE will look at economic indicators such as:

  • GDP growth
  • Unemployment rates
  • Inflation
  • Sentiment surveys.

If the economy is in danger of ‘overheating’ (think high inflation rates, very low unemployment rates, and a sharp uptick in economic activity), the BoE may look to ’tighten’ monetary policy by raising rates. This has the effect of increasing the cost of money in the economy and is likely to reduce borrowing and spending.

Conversely, if the economy is in danger of stagnating, the BoE may look to give it a boost by loosening monetary policy and cutting rates. This should stimulate borrowing, investment, and expenditure.


The yield curve can provide insights into interest rate expectations

Many investors look to the yield curve to assess the outlook for interest rates. But what is it?

The yield curve is a graphical representation of bond yields for each different maturity date at a given moment in time. Bond yields themselves are a derivative of the price of a bond and so are driven by demand and supply. The yield curve is an illustration of market sentiment; it is not a forecast, or a guarantee, and it changes continuously. Generally, the yield curve of government securities is closely monitored.



The above chart is a snapshot of the UK gilt yield curve taken in early March 2024 compared to the same chart from one year prior. It shows gilts with maturities from six months to 50 years. By comparing the two curves side by side, you can see how yield and rate expectations are different from the previous year.

The curve can move quickly if there ae significant changes in the market environment or economic data. In any event, the yield curve is not a guarantee for future policy decisions from the central banks.

The yield curve can provide you with information about likely changes to mortgage and interest rates at banks in the short-term. For example, if you wanted to understand the likely changes to 5-year mortgage or deposit rates, you could look at changes to the 5-year gilt yield. Bank rates (on both lending and deposits) generally follow the same path with a short lag.

In a ‘normal’ environment, the yield curve slopes upwards (this characterises a positive outlook for the future economy), reflecting the expectation of investors to receive a higher compensation (yield) for the increased risk associated with holding bonds for longer periods.

Changes to the yield curve can be used as an indicator of a change in market sentiment for the future on interest rates, as well as on the outlook for an economy in general.

If the yield curve inverts (i.e. longer-term yields are lower than shorter-term yields), this can be an indicator of an impending economic deceleration, broadly speaking, as investors race to ‘lock in’ capital in longer term bonds for security, expecting markets and rates to fall in the shorter term.

At Arbuthnot Latham, our Investment Committee, looks at the same metrics that the central banks consider (economic growth, employment, inflation etc.) as a way of estimating the directional forces that would influence both short- and long-term rates, to inform our portfolio positioning. This is challenging; however, we have successfully managed our portfolios’ sensitivity and exposure to interest rates over the past five years, taking advantage of how rates have moved.

A diversified approach can help mitigate fluctuating interest rates

While the yield curve, alongside market data and central bank guidance, can be helpful for understanding interest rate expectations, the challenge is that the landscape is ever-changing. For example, towards the end of 2023, with inflation rates falling in the US, UK and Europe, expectations were that we may see rate cuts as early as the first half of 2024. However, in early 2024 we saw some inflation readings surprise to the upside and the expectation for rate rises have now been pushed back.

This is why having a diversified approach to portfolio management is key. At Arbuthnot Latham, we adjusted our portfolios at the start of 2024 to reflect the opportunities that we see in the fixed income market with the prospect of rates falling this year. But importantly, we have not pivoted entire portfolios on this thesis. We have some positions that would fare well if rates do fall, but we have other assets that will fare better if this does not happen.

If you are weighing up financial decisions around borrowing, saving, or investing, which are all affected by interest rates, we can help.



Get in touch to speak to one of our experts

Further Reading


Rising inflation, rising interest rates: save or invest?

Post-covid fall out, Brexit and the war in Ukraine have led to market turmoil. As central banks look to temper inflation, it raises interesting questions for investors.


Is it time to say goodbye to fixed rate mortgages?

Are you coming to the end of a fixed rate mortgage deal? Navigate the UK mortgage landscape with insights on fixed vs tracker rates, interest rate predictions, and strategic decisions.

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Author -

Gabriella Macari

Gabriella Macari

Senior Investment Manager

Gabriella Macari, Senior Investment Manager at Arbuthnot Latham, rejoined the Bank in 2023. Gabriella had previously been part of the Arbuthnot Latham team from 2019 to 2022. Throughout her career, she has actively contributed to various research teams, showcasing her expertise in financial analysis.

Gabriella's experience includes leading the Commercial Property research division. She also played a pivotal role in the development and launch of the Sustainable Portfolio Service in 2021.

Gabriella holds the title of Chartered Wealth Manager, Investment Advice Diploma and the Private Client Investment Advice and Management qualification. She holds a BSc (Hons) in Economics from the University of Bath.

Outside of her professional life, Gabriella enjoys cooking, finding joy in creating delicious meals. She is also a dedicated runner and maintains an active lifestyle. Additionally, Gabriella is a Formula 1 enthusiast, highlighting her interest in the world of motorsports.


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