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The yield on U.K. 10-year notes rose past 1% for the first time since March 2020, while the pound plummeted, as U.K. assets confronted a mix of accelerating inflation expectations accompanied by curtailed growth from an expected tightening cycle.
The rate on benchmark gilts rose as much as 11 basis points to 1.06% on Tuesday, the highest level since the market turmoil in March 2020. They haven’t closed above 1% since May 2019. The move comes after some U.S. Treasury yields hit similar pandemic-era milestones.
The pound, meanwhile, was headed for its worst day in a year. It fell as much as 1.3% to $1.3523, its lowest level since January. While many would expect it to benefit from higher domestic rates, surging energy prices and panic-buying are keeping investors cautious. The Bank of England noted the limits of monetary policy in responding to such shocks earlier this week.
“I see this as a shock reaction to the ongoing inflation surprises,” said Jordan Rochester, a strategist at Nomura, who remains bullish on the currency. “Real yields are messy but explain why sterling hasn’t performed, because if you were following nominal yields the euro-pound cross should be much much lower.”
U.K. sovereign debt has been at the forefront of a global bond selloff in recent sessions after last week’s BOE meeting prompted traders to bring forward rate-hike expectations. In a speech on Monday, Governor Andrew Bailey reinforced the notion that interest rates could rise as early as this year, even before the current bond-buying program is due to expire if necessary.
John Wraith, head of U.K. and European rates strategy at UBS AG noted it was “concerning” that the move was manifesting through higher inflation expectations rather than real yields. The fact that inflation-adjusted yields remain low “suggests the selloff is not being caused by rising optimism around the outlook for real growth and activity,” he added.
U.K. 10-year breakevens -- a gauge of compensation for price increases derived from the yield differential between nominal and inflation-linked debt -- are nearing 4%, a level it hasn’t breached since 2008. Money markets currently see the BOE raising rates by 15 basis point points in February, followed by a further quarter-of-a-percentage point rise to 0.5% in August.
The rise in nominal gilt yields follows an ascent in U.S. yields, after the Federal Reserve signaled last week that it could start winding down its asset purchases soon. Treasury two- and five-year yields jumped to their highest in at least 18 months while 10-year yields surged past 1.50%.
Concerns over the impact of price pressures on longer-term debt are reverberating across other corners of the bond market. An auction of 30-year gilts on Tuesday saw the weakest demand for the maturity -- as measured by the bid-to-cover ratio -- since July 2020.
Peter Chatwell, head of multi-asset strategy at Mizuho International Plc, expects the 10-year gilt yield to reach 1.10% by the end of the year.
“The repricing of BOE rate expectations will prove sticky,” said Chatwell, who sees the central bank’s key interest rate reaching 1.5% by 2025. “The forward path of U.K. rates is still far too low, the curve should be much steeper.”
(Updates with comment in fourth paragraph, markets context throughout.)
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