BOE Seen Boosting Pace of Hikes After Shock Inflation Reading

Traders are betting the Bank of England will have to accelerate the pace of interest-rate hikes to get a handle on inflationary pressures plaguing the economy.

(Bloomberg) — Traders are betting the Bank of England will have to accelerate the pace of interest-rate hikes to get a handle on inflationary pressures plaguing the economy.

Money markets shifted on the back of a report Wednesday showing inflation remained at 8.7%, higher than expected for a fourth month. While the BOE on Thursday is expected to raise rates by 25 basis points to 4.75%, the risk of a larger half-point increase is growing, and is now fully priced by August. 

Traders also lifted expectations for the terminal rate to 6%, which would be the highest since the turn of the century. The pound fell along with gilts, with two-year yields rising to levels last seen in 2008.

The UK has already been through the quickest tightening cycle in 40 years, and lifting the rates further would add to the pressure on borrowers, deal another blow to the housing market and raise questions about the outlook for the broader economy. Still, traders and analysts say more aggressive action may be warranted regardless.

“Inflation is an elusive, wily and powerful foe especially when it builds up momentum, as it is now. There is a strong argument for a 50-basis point hike at tomorrow’s Bank of England’s meeting,” said Charles White Thomson, CEO at Saxo Capital Markets UK. “The Bank needs to take the initiative quickly. The risk for further policy failure is real and the stakes are getting increasingly high.” 

Just a month ago, bets were on a terminal rate below 5%, and the rapid repricing has started weighing on the pound. Despite a spike in yields, the British currency fell against the dollar and the euro on Wednesday, underperforming all its Group-of-10 peers. It was trading 0.2% weaker at $1.2739 as of 4:40 p.m. in London.

UK Stagflation Fears Add to Pound’s Woes Despite Higher Rates

“There’s an argument that if higher rates begin to pressure the UK’s economic growth, the pound will weaken,” said Ian Tew, head of G10 FX spot trading at Barclays Plc. “Feels like today’s higher inflation maybe the start of it.”

Many households are already struggling because of the cost-of-living crisis, and an additional squeeze, plus worries about the economy, would add to the political headaches for Prime Minister Rishi Sunak. He says his focus is on lowering inflation. On Tuesday, Chancellor of the Exchequer Jeremy Hunt ruled out special mortgage support because it would only exacerbate price growth.

The last time traders were so hawkish on the outlook for interest rates was in September, when former prime minister Liz Truss shocked markets with huge spending plans. But sticky inflation and a tight labor market have led them to ramp up tightening bets once again, in contrast with their peers in the US and the euro zone, where policymakers are seen nearing the end of tightening cycles.

“The UK is in a situation that is worse than Europe and the US, the risk of inflation expectations de-anchoring is the highest in the developed world,” said Raphael Gallardo, chief economist at Carmignac Gestion SA. “The Bank of England has to keep hiking.”

The shifting outlook further inverted the UK yield curve, suggesting the market expects rates to eventually fall as growth begins to slow. The 10-year yield is now almost 70 basis points below the two-year rate, the most since 2000. 

“Higher inflation, higher growth. It’s not a good reason to own gilts,” said Kim Crawford, global rates portfolio manager at JPMorgan Asset Management, adding there’s a compelling case for a half-point hike on Thursday. “Recession is going to be required to get this inflation under control.”

–With assistance from Alice Gledhill, Greg Ritchie and Naomi Tajitsu.

(Updates market moves throughout.)

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