RPT-UPDATE 1-Short UK bond yields rocket as investors ramp up rate hike bets

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* Rise in natural gas prices raised fears of inflation

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* German-UK bond yields widest since 2016

LONDON, Oct 11 (Businesshala) – British government bond yields rose to their highest level in two-and-a-half years on Monday as investors became increasingly confident the Bank of England would raise interest rates before the end of the year.

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The high came in light of comments from BoE Governor Andrew Bailey and fellow rate-setter Michael Saunders, who both stressed the need to prevent rising inflation expectations from becoming embedded.

Investors have chosen to gilt a heavy sell-off in key government bond markets, indicating not only the prospect of a BoE rate hike, but a decision that the UK appears to be particularly prone to inflationary pressures.

Britain was in disarray in recent weeks as a shortage of truck drivers left fuel pumps across the country dry and soaring wholesale natural gas prices prompted many energy companies to go bankrupt.

Underscoring the turmoil in British markets, Goldman Sachs on Friday said it expects the 10-year yield to reach 1.2% by the end of the year.

As it happened, the 10-year yield jumped over 1.2% in early trade on Monday, up from last week’s 1.16% and its highest mark since May 2019.

While the short-dated gilt yield saw the biggest increase on Monday, the 2-year yield rose above 0.6% for the first time since January 2020 – 7 bps on the day.

Kenneth Brooks, an FX strategist at Societe Generale in London, said Bailey’s and Saunders’ comments only served to fuel a growing belief among investors that the BoE would raise interest rates by the end of the year.

“They’ve been banging the drums since the last meeting, so you have to take it seriously that they can go up to November. Labor market figures tomorrow and then GDP on Wednesday will certainly add suspense,” Broux said.

The BoE is now likely to raise interest rates long before the US Federal Reserve and the European Central Bank. This marks a marked change in market sentiment, which only last month pointed to a rate hike in the second half of 2022.

Reflecting this, the gap between yields for the 10-year gilt and the equivalent, lower yield widened to 132 bps on Monday, the biggest spread since 2016.

Interest rate futures traded on the CME showed that November contracts had a 20% chance of a BoE rate hike next month as compared to 12% the previous week, while December futures saw a rate hike of 45% by then. There was a possibility.

A separate estimate by Refinitiv, based on interest rate futures, suggested that the 15 bps rate hike as of December is now fully in value.

Some investors have already been burned by the price rush in the BoE rate hike.

On Monday, RBC said it pulled out of its recommendation to go long on the March 2022 Sonia futures, which was made on the grounds that it felt the market had priced BoE rate hikes too aggressively.

“The business continues against us, and we have been put on hold,” the bank said in a note to customers.

Reporting by Andy Bruce; Editing by Toby Chopra

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