Bets on the trajectory of the Bank of England’s key interest rate surged to the highest level in a quarter century as traders questioned officials’ ability to tame inflation without hobbling the UK economy.
Money markets are now fully pricing another half-point hike in August and a 6.5% interest rate by February, with almost one-in-two odds of an even higher 6.75% peak, according to interest-rate swaps tied to policy-meeting dates. That would be the highest since 1998 and compares with wagers on a 5% peak just a couple of months ago.
Yields joined the surge, with UK 10-year government borrowing costs rising to the highest since 2008 at 4.64% after stronger-than-forecast US private payrolls data.
Pushing borrowing costs to such levels would drive mortgages deeper into the BOE’s pain zone, making credit for businesses less affordable and delivering a sharp blow to an economy that’s been sputtering since the pandemic. That would add to the difficulties facing Prime Minister Rishi Sunak’s government ahead of an election widely expected next year.
“The more yields rise, the more it scares buyers away because no one wants to catch a falling knife,” said Rishi Mishra, an analyst at Futures First Canada. “If it were just about levels, these are good enough levels for buyers to step in.”
Policymakers have delivered 13 successive rate increases since late 2021, including an unexpected half-point hike last month, yet UK inflation at 8.7% has beaten estimates four months running and still remains well above the BOE’s 2% target.
BOE Governor Andrew Bailey said inflation is still “far too high” in comments on Thursday, and pointed to signs of so-called “greedflation,” although he suggested the pace of price growth should fall sharply this year.
Glimmer of Hope
There was also a glimmer of hope after the BOE’s survey of chief financial officers showed expectations for price gains slowed in June. The rate seen in the next 12 months dropped to 5.7% in June from 5.9% in May. The single month figure of 4.9% for June was the weakest pace anticipated since February last year, when Russia invaded Ukraine and sent energy prices soaring.
For now, the monetary policy tightening is filtering through to the economy.
Higher rates are adding to the cost of servicing UK government debt, constraining the ability of Sunak’s administration to offer the tax cuts it wants to promise voters in time for the election. On Wednesday, the UK Debt Management Office sold a gilt at the highest average yield since 2007.
It’s also likely to sharpen the worst cost-of-living squeeze on consumers in generations.
Over a Third of UK Homes Dropped in Value in the Last Six Months
JPMorgan Chase & Co. economist Allan Monks said there’s a risk the BOE will have to push interest rates to as high as 7%, triggering a “hard landing” in the economy. Schroders Plc also expects policymakers to prioritize inflation over growth by raising the bank rate to 6.5%.
“The lack of BOE policy rate guidance and uncertainty regarding inflation trajectory,” means traders are unwilling to bet against rates going higher, according to Evelyne Gomez-Liechti, a rates strategist at Mizuho International Plc.
--With assistance from Reed Landberg and Andrew Atkinson.
(Updates with BOE peak pricing in the second paragraph and 10-year yield in the third paragraph)
