BOE Rates Traders Should Fret About Effect of U.K.’s Twin Tightening

(Bloomberg) --

Governor Andrew Bailey was pretty explicit about the rising path for the Bank of England’s policy rate. Traders have already priced this in, with a steep track through next year, but they may have to reassess when the economic fallout from simultaneous tightening on the monetary and fiscal fronts become clear. 

Traders are betting that the bank will start raising rates in the final months of 2021, and that the benchmark will reach 1% by end-2022. Money markets now see 36 basis points of rate increases in December and are pricing 15 basis points of tightening next month, with two-year rates rallying on Monday. 

Markets are more attuned to the risks of slowing U.K. growth, with bets against the pound intensifying and a flattening of the yield curve with longer-term rates coming under pressure since last week. 

There’s no misreading Bailey’s words when he said the central bank will “have to act” to curb inflation. Yet this comes just as fiscal drawstrings are tightened too. Chancellor of the Exchequer Rishi Sunak is on course to raise taxes and cut spending to control the budget deficit. The key-rate path may be curtailed if this leads to slower growth.

That’s a double whammy the economy can ill afford. Already, figures released this month showed the economy grew less than expected in August following an unexpected drop in output the previous month.

It’s also doubtful that the supply-chain and commodity-price inflation that the economy is experiencing will be influenced by monetary policy. Natural-gas storage levels won’t be affected by U.K. interest rates -- unless it leads to a substantial amount of demand destruction. And that’s not something Bailey wants to see.

• This was a post on Bloomberg’s Markets Live blog. The observations are those of the blogger and not intended as investment advice. For more markets analysis, go to MLIV.

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