The UK economy to get more clarity over the next couple of days

The UK economy to get more clarity over the next couple of days.

Britain’s bond market is approaching an inflexion point, with inflation data and a Bank of England decision set to shape the outlook for traders after yields have risen to the highest level since 2008.

These two events, due over 30 hours starting Wednesday morning, could bring a halt to upward momentum in interest-rate bets. Official data is expected to show inflation slowed to its lowest in 14 months, while investors are pricing in a 13th consecutive rate hike from the BOE to bring wage-price pressures under control.

BlackRock Inc., Invesco Asset Management and Royal London Asset Management are already dipping back into the market. They argue — along with many economists —  that traders are anticipating more hikes than the BOE is likely to deliver, and it’s an opportunity to lock in some of the highest bond yields in the developed world.

“The market’s pricing of five more hikes from the BOE is very unlikely,” said Alexandra Ivanova, a fund manager at Invesco. “The Bank has a lot of constraints making it unable to deliver on these expectations. Growth is one of them, and inflation is almost certainly a structural issue.”

Britain has the worst inflation problem in the Group of Seven nations but the outlook is improving, thanks largely to a sharp drop in electricity and natural gas prices as well as slower growth in the cost of food.

Economists expect the inflation rate to decelerate to 8.4% in May from 8.7% in April. BOE officials see inflation easing further for the rest of the year.

The release will loom large over the Monetary Policy Committee’s thinking as it prepares to set rates on Thursday. The median estimate in a Bloomberg survey is for a quarter-point increase of 4.75%, the highest since 2008.

“The BOE’s near-term messaging will depend heavily on the inflation print,” said Bruna Skarica, an economist at Morgan Stanley. She is pencilling in a 25 basis-point hike, yet doesn’t anticipate “overly hawkish messaging” from the MPC ahead of the August forecasting round.

The market is less sanguine. Traders drove up rate expectations over the last few weeks after labour market data showed an unexpected tick down in unemployment, indicating wage pressures will continue for some time.

They now see four additional hikes until the end of the year and attribute a small chance of a final move to 6% in early 2024, which would be the highest since the turn of the century.

Some investors believe the turning point in interest rates is near. They are moving to lock in returns, betting yields may not rise much further.

Invesco bought long-duration gilts last week when yields surged to the highest since 2008. BlackRock recently ditched a long-held underweight position, while Royal London Asset Management also used the selloff to buy UK government bonds.

It might not be the high, but it will be close and traders learn to accept that they’d rather be close than nowhere near. We have to be prepared to be wrong short-term, to be right long-term. Get the price you’re happy with, and leave it.

There is some speculation among investors that a string of hotter-than-expected pay and inflation data could prompt the Bank of England to opt for a 50-basis-point hike at its June meeting. We think that’s unlikely.

Rate expectations have already moved materially higher — the central bank doesn’t need to provide a further impulse with a hawkish surprise. Our base case is for a 25-bp move.

The main issue the market must weigh is that the tightening price now would be a disaster for what’s an already fragile economy.

We also believe that the market has gone too far in its future expectations of where the terminal rate is. We’ve seen a temporary ‘banking crises’ that was averted quickly. This happened as the FED increased rates quickly, and a few smaller high-street lenders were found out due to poor risk management.

We always say that it’s hard to know where the next problem will come from, but increasing interest rates at this pace will certainly cause the next problem. The BoE knows this, and they will be more cautious than the market expects. We desperately need a lower inflation figure, and we need wages to stop rising.

If prices slow, the Bank can slow, stop, and then eventually look to turn around. Increasing rates should be done gradually to avoid shocks to the consumer. They have done what they’ve done for exactly this reason, the economy needed a shock to reduce prices. But they need to stop before the damage can’t be stopped.

The BOE anticipates medium-term growth of around 1%, far lower than the rate of inflation and tightening a cost-of-living crisis. Rates anywhere near 6% would squeeze the economy further, with more than 1 million households due to refinancing their mortgages this year.

That all points to a stagnating economy with slower price growth, opening the door for the BOE sometime this year to halt its quickest series of rate hikes in four decades.

Our fingers are crossed for the UK consumer. With any luck, the scaremongering from the press will do much of the work for the Bank, and prices will dip. Mortgage refinancing could lead to a systemic risk, lower interest rates might mean we’re paying a bit more for our shopping; there’s no right answer, but there could be a wrong one.

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