Hot UK inflation spurs biggest bets on rate cuts in 15 years

Bloomberg

Faster inflation would normally fuel expectations for higher interest rates. In the UK, where price gains are the quickest in three decades, traders are betting on rate cuts.
They’re paying heed to a warning this month from the Bank of England that surging costs for energy, clothing and food could lead to a weaker growth outlook. Money markets show wagers for more than a quarter-point in rate decreases within the next two years, the most aggressive positioning since 2007.
It’s a stark contrast from last month, when a bumper 50-basis-point hike by May was seen as a done deal. Those bets evaporated by the end of February amid Russia’s invasion of Ukraine, and have not been fully revived by data last week showing the consumer price index in February hit levels last seen in 1992.
Instead, traders are bracing for the impact of the current cycle of policy tightening — which has delivered 65 basis points in hikes since December — on the longer-term growth and price trajectory.
“Ironically, higher CPI now reinforces the medium-term disinflationary narrative,” said Antoine Bouvet, a strategist at ING Bank NV, adding “CPI readings are not as impactful in part due to the string of
positive surprises.”
Readings for UK CPI have beaten median estimates in Bloomberg economist surveys since October, gradually eroding the element of surprise each time.
In that time, money markets at one point wagered on more than a percentage point of rate hikes by the end of this year, before rolling it back in November after policy makers surprisingly held the bank rate steady as omicron spread.
Traders ramped up bets again in the aftermath of the BOE’s rate increase in December, its first since 2018, before trimming them after Russia invaded Ukraine. Following the inflation data, money markets now price about 139 basis points of further tightening this year.
The BOE’s quarter-point rate hike on March 17, which took borrowing costs back to their pre-pandemic level, was accompanied by policy makers warning the war in Ukraine may push inflation well above 8% later this year. Yet they also tempered the outlook by saying that a further tightening of policy “might be” appropriate in the coming months, a softening from the wording in February, when they said such a move was “likely.”
The central bank forecasts CPI inflation will fall back to slightly above its 2% target in two years, and below it in three years.
“I wouldn’t say this is disinflation but more a typical rate cycle which is central banks raising rates that eventually chokes off growth and hence a reversal in policy in due course,” said Charles Diebel, head of fixed income at Mediolanum International Fund. “Its monetary policy 101.”
Any hopes for more fiscal support were dashed last week, when Chancellor of the Exchequer Rishi Sunak’s package of tax cuts was deemed not doing enough to stem a record drop in real disposable incomes.
The measures “may prove insufficient to prevent a notable slowdown in demand,” Daniela Russell, head of UK rates strategy at HSBC Holdings Plc, wrote in a note. She recommends positioning for further divergence between gilts and US Treasuries, whose yields have been driven higher by a hawkish stance from the Federal Reserve.
The yield on US two-year bonds jumped the most since 2009 last week, while the spread between five- and 30-year securities fell to the lowest since 2006.
“It now seems that the Bank may soon be ready to start slowing the pace of tightening,” Russell wrote. “The risks are skewed to an earlier pause –- and fewer hikes.”