(Bloomberg) -- Investor sentiment on gilts soured after the U.K. clinched a Brexit transition deal with the European Union on Monday. But that mood isn’t likely to last.
All the market telegraphed was that the Bank of England will more likely than not raise its policy rate in May, according to UBS Group AG. As the realities of the challenging path ahead for the U.K. economy become clearer, gilts will be bought again, HSBC Holdings Plc said.
“Even if you get a short-term rise in yields in the front end in response to a transitional deal, that will run out of steam later in the year as it becomes evident that the problems that lie ahead are much greater than the ones that have been negotiated,” said John Wraith, head of U.K. rates strategy at UBS.
Benchmark 10-year gilt yields were at 1.46 percent after touching a 10-day high of 1.51 percent on Monday. The spread to German bunds was little changed compared with Monday’s close of 88 basis points, which was the widest this month. Wraith sees the gap narrowing to 50 basis points by the end of this year, a level last seen in 2013.
HSBC forecasts the 10-year gilt yield to end the year at 1.30 percent and the equivalent bund yield at 0.9 percent, resulting in a spread of about 40 basis points, even narrower than UBS’s prediction.
“We see quite a significant cross market outperformance” in U.K. bonds, UBS’s Wraith said. “We would caution that this deal isn’t a sort of panacea. As you move into summer and the second half of the year and suddenly the focus intensifies on that withdrawal agreement, it will start to have implications for the market.”
Monday’s pact supports the view that the BOE will raise rates in May, with markets now pricing an almost 85 percent probability of that happening, compared with about 80 percent before the deal was announced.
While the broad agreement helps clear the way for a BOE hike then, this week’s data, which include employment numbers, “will be just as important -- if not even more so,” said Daniela Russell, head of U.K. rates strategy at HSBC. “The market is already almost fully pricing a hike for May, but another weak labor market report or poor retail sales number could cast some doubts.”
A report released on Tuesday showed U.K. inflation slowed more than forecast in February, weakening the case for tighter policy.
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