U.K. Pays Most Since Brexit Vote to Borrow Compared to Germany
U.K. government bond yields have climbed to levels last seen before the Brexit referendum in 2016 relative to German peers, as traders brace for inflation in Britain over the next decade to far outpace the rate in Europe’s largest economy.
The extra yield investors demand to own 10-year gilts over equivalent bunds jumped to more than 125 basis points this week, up from around 80 basis points at the start of the year. It comes as market-based expectations for consumer-price increases over that time frame pushed past 4%, more than double the gauge in Germany.
The divergence is driven partly by shortages that resulted from U.K.’s departure from the European Union, with households now facing higher costs on for everything from turkey to toys. And it’s fueling speculation that the Bank of England will have to tighten monetary policy as soon as February or risk a further increase spurred by surging energy prices.
“In the short term there is more potential for gilt yields to rise,” forcing the BOE into hiking rates, said Althea Spinozzi, a strategist at Saxo Bank A/S. “In Europe, although inflationary pressures are intensifying, they are not as pronounced.”
U.K. wage growth rose at its strongest pace on record in a survey of job recruiters, the latest sign of strains that a shortage of workers is creating.
The outlook is also exposing a widening gulf with the European Central Bank, where officials are clinging on to the view that the latest bout of inflation won’t last amid signs the growth momentum is stalling. They’re also mulling a new bond-buying program, according to officials familiar with the matter.
Money markets are betting the BOE will hike interest rates by 25 basis points in February and raise its key rate to 0.75% by September 2022. The ECB is expected to hold rates unchanged until 2023.
What’s more, if Berlin fails to stitch together a ruling coalition by December, the spread between 10-year gilts and German bonds could rise to as high as 150 basis points, Spinozzi said. There was no outright winner in elections last month raising the prospect of a rush for haven assets should talks fall through.
The divergence is also evident in the credit market, where the spread between borrowing costs for investment-grade sterling bonds maturing within five to seven years and their euro-denominated peers rose to the widest since March 2020, according to Bloomberg indexes.
“At the end, it comes down to which central bank is going hike interest rates first,” Spinozzi said. “And for sure that’s going to be the BOE.”
©2021 Bloomberg L.P.