UK bonds sell off as high inflation raises expectations of BoE rate hike

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Short-term borrowing costs in the UK have risen to their highest level since 2008 as searing inflation data bolstered expectations that the Bank of England will need to raise borrowing costs sharply to slow inflation. price growth.

Yields on two-year gilts, which are sensitive to monetary policy expectations, climbed 0.3 percentage points on Wednesday to 2.45%.

Longer-term bonds came under slightly less selling pressure, with the 10-year yield rising 0.19 percentage points to 2.32%.

The moves spilled over into other global bond markets, with German, Italian and US government debt under pressure.

The intense sell-off in UK short-term debt highlights that many investors increasingly view the BoE as lagging behind in its efforts to tackle inflation, which is at its highest level in more than a decade. 40 years. There are also fears that these efforts could tip the country into a prolonged recession.

Rising two-year gilt yields “tell us that the market thinks the [BoE] the bank rate needs to go up,” said James Athey, chief investment officer at Abrn.

Athey added that the positioning of some investors who hoped inflation was near its peak had “exacerbated” Wednesday’s moves as they now had to shift to a more hawkish outlook for monetary policy.

In currencies, the pound slid 0.4% against the dollar to $1.20 and 0.4% against the euro to €1.18.

Trading activity in the fixed income and currency markets tends to slow in August as many market participants are on vacation, which can amplify the magnitude of price swings.

Wednesday’s measures come after new data showed the UK’s annual inflation rate rose to 10.1% in July, from 9.4% in June and above economists’ forecast of 9.8 %.

The Office for National Statistics noted that a “wide range of price rises” pushed up the inflation rate in July, with food leading the way. “The main issue was the magnitude of the price increases,” said Silvia Dall’Angelo, senior economist at Federated Hermes.

Goldman Sachs economists said they expect prices “to remain elevated through 2022 and 2023 due to supply chain disruptions, strong wage growth and rising wages.” energy prices.

Bank of England rate hike expectations push higher

The UK data contrasts with the US inflation report earlier this month, which showed consumer price growth in the world’s largest economy slowed to 8.5% in July, from 9.1% in June. Easing cost pressures in the United States had raised hopes that global inflation could peak or approach.

“The encouraging evidence that the upward pressure on core inflation from global factors has started to ease will be of little reassurance to the Bank of England given signs that this is being replaced by inflationary pressures. more persistent national policies,” said Ruth Gregory, senior UK economist at Capital Economics.

Trading in the money markets now suggests traders are bracing for the BoE to raise its main interest rate by 2.05 percentage points by May 2023, up from 1.67 percentage points on Tuesday.

Gregory said she expected the BoE to raise rates by 0.5 percentage points next month, after raising them by the same margin this month in the biggest hike in 27 years. The central bank has already raised its main interest rate from 0.1% in November 2021 to 1.75% this month.

The hawkish pivot in market prices left two-year gilt yields trading around 0.15 percentage point above their 10-year counterparts, the biggest ‘inversion’ in the UK yield curve since the global financial crisis of 2008.

Investors generally demand higher borrowing costs for the risk of buying long-dated bonds, which means that yield curves normally slope upwards. An inverted curve is a strong signal that markets expect a more aggressive BoE to deal a heavy blow to the country’s economy.

Difference Between Two-Year and Ten-Year Gilt Yields

The inverted yield curve signals that markets are pricing in a near-term tightening of monetary policy by the BoE, followed by a recession and then “a bit of easing” from the central bank, it said. said Dall’Angelo.

Earlier this month, the central bank warned that the UK would slide into a recession 15 months later in 2022, with gross domestic product falling more than 2% from peak to peak.

“We’re almost getting to the point where central banks are almost going to have to engineer a financial crisis-like unemployment market to get inflation under control,” said Craig Inches, head of rates and liquidity at Royal London Asset Management. , pointing to the BoE and other global counterparts such as the US Federal Reserve which are also battling high inflation.

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