U.K. Inflation Expectations at 13-Year High Lift Rate-Hike Bets
A market-based measure of expected inflation in the U.K. over the next decade topped 4%, bolstering wagers for tighter monetary policy.
The so-called 10-year breakeven rate climbed as much as 10 basis points to 4.08%, the highest since 2008. The move was spurred by a spike in energy costs with U.K. natural gas prices surging to a record, threatening to fuel higher consumer prices.
In response, money market have almost fully priced a rate hike from the Bank of England as soon as December, in what would be its first increase in over three years.
It comes at a fragile time for the U.K. economy, which is still recovering from the pandemic and which faces supply shortages related to the fallout from Brexit. Some investors are warning that tighter policy risks jeopardizing the rebound.
“Rate hikes are not going to help with the winter demand for gas,” said Rishi Mishra, an analyst at Futures First. “The last thing you want to do in a situation where people are already losing part of their disposable income to energy is to make them pay higher interest rates.”
The Times newspaper also reported Prime Minister Boris Johnson will announce a rise in the minimum wage to about 9.42 pounds ($12.78) per hour within weeks, further muddying the outlook.
Inflation in the U.K. accelerated to the strongest pace in more than nine years at 3.2% in August, with the BOE leaving the door open to a potential interest-rate hike as soon as November to contain the surge. Officials expect inflation to exceed 4% in the final quarter of 2021.
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The move in inflation markets reverberated across other asset classes. The yield on sterling investment-grade corporate bonds was a whisper away from breaching 2% for the first time since June 2020, according to a Bloomberg index.
Money markets currently see policy makers raising rates by 15 basis points in February, followed by a quarter-of-a-percentage point rise to 0.5% in May. They have almost fully priced in a 15-basis-point hike in December.
The breakeven rate -- which also reflects a risk premium related to inflation uncertainty, liquidity and hedging flows -- is derived from the difference between conventional gilts yields and those linked to inflation.
Payouts on the securities are currently linked to the Retail Price Index, rather than the Consumer Price Index targeted by the BOE. During the last 12 months RPI inflation has averaged more than 1 percentage point more than CPI.
Still, expectations for price increases are at their most extreme in the near term, with one-year inflation swaps above 6%. Yet longer-dated contracts have not kept pace, supporting a view that inflationary pressures will be somewhat transitory.
“The inflation market has been pushed to extreme levels,” said Tanvir Sandhu, Chief Global Derivatives Strategist at Bloomberg Intelligence. “It remains at the mercy of actual inflation prints and bullish momentum.”
©2021 Bloomberg L.P.