Traders ramped up bets on further interest-rate hikes from the Bank of England after UK inflation unexpectedly remained in double digits, a wake-up call for investors who thought the tightening cycle was close to over.
(Bloomberg) — Traders ramped up bets on further interest-rate hikes from the Bank of England after UK inflation unexpectedly remained in double digits, a wake-up call for investors who thought the tightening cycle was close to over.
Data showed consumer prices rose 10.1% in March from a year earlier, driven by the biggest increase in food costs in more than four decades. That follows strong wage growth reported Tuesday, adding to concerns that UK inflation is proving stickier than anticipated.
The market is now fully pricing two consecutive 25 basis-point BOE hikes in May and June, with a further increase expected later in 2023 that would take the key rate to 5% by September, the highest anticipated by traders this year. Economists from firms including Deutsche Bank AG, Morgan Stanley and Nomura Holdings Inc. revised up their forecasts for the terminal rate.
“The market needs clearer signals that inflation is coming down decisively for real demand to return to fixed income,” said Imogen Bachra, head of UK rates strategy at NatWest Markets. She sees a further bond selloff taking the 10-year gilt yield up to 4.3%, from around 3.8% currently.
For weeks, investors had been emboldened by signs of tighter financial conditions and concern that the full impact of previous rate rises has yet to hit. Wagers on the BOE’s terminal rate fell to as low as 4.38% in March when the market was grappling with the fallout of banking stress in the US and Europe, on speculation that the crisis would limit the need for aggressive tightening.
“Inflation may not be as controlled as markets — and the BOE — thought it to be,” said Evelyne Gomez-Liechti, rates strategist at Mizuho International Plc. “The data is delivering a clear message to the BOE: it’s too early to pause.”
Government bonds slid as traders readjusted their expectations. Two-year gilt yields, among the most sensitive to policy changes, jumped as much as 15 basis points to 3.84%. The pound rose as high as $1.2472 before erasing gains, yet still outperformed other Group-of-10 currencies against the dollar. Its bounce back this year is a turnaround in fortunes, after sterling slumped to a record low against the US dollar in September.
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Bets on the BOE’s peak rate could rise even further before policymakers’ next gathering on May 11, said Roberto Cobo Garcia, head of G-10 FX strategy at BBVA. In contrast, traders only expect one more quarter-point hike by the Fed and the widening interest-rate differential should help underpin sterling.
Britons are already struggling with a cost-of-living crisis, which is draining support for the ruling Conservative Party. Prime Minister Rishi Sunak has made halving inflation by the end of the year one of his five key promises to voters, who have suffered large pay cuts in real terms. Any failure to do so could embolden unions to hold out for bigger offers in wage negotiations.
Economists still expect a slowdown in inflation from April because of powerful base effects as last year’s rapid energy price increases fall out of the figures. But BOE hikes to 5% would likely increase the cost of mortgages, which have eased recently after a surge in the wake of former prime minister Liz Truss’s mini-budget. Mortgage rates are still almost double their level a year ago, according to property website Rightmove.
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The latest inflation readings will prove a headache for BOE officials, amid concern they risk raising rates too far given the pressure on economic growth. Two doves on the BOE’s nine-member rate setting committee have voted to keep rates unchanged for several months.
Nomura and Deustche Bank, which expected no more rate hikes this year, now see two additional quarter-point moves, while Morgan Stanley added one hike to its base-case scenario and acknowledged risks of a subsequent increase.
“The picture being painted by the data released so far this week will likely be raising concerns inside the BOE,” said Stuart Cole, chief macro economist at Equiti Capital in London. “This likely means a continuation of its hiking cycle, a lengthening that will come at a time when peers such as the Federal Reserve will likely have paused with their own cycle of interest-rate rises.”
–With assistance from Naomi Tajitsu, James Hirai and Tom Rees.
(Adds economists’ forecast changes in paragraphs 3 and 12.)
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