Traders are wagering the Bank of England’s key rate will soon overtake the Federal Reserve’s as UK policymakers amp up their inflation fight.
Market-implied projections of where the British key borrowing rate will be between one and three years from now have overtaken US equivalents. They show how investors now expect the BOE to intensify the tightening cycle, with its key rate peaking at around 3.75% as early as March and staying there for months before slowly tracking lower.
The flip in pricing was triggered by hotter-than-expected UK inflation data Wednesday, with price increases set to accelerate further amid a winter energy crunch. It’s the first time UK forward rates for around three-years from now have been higher than US peers since the market disclocations caused by the pandemic in early 2020.
“Arguably, the long-term level of rates should be higher for the US so over the longer run -- say three years -- I don’t think higher forward UK policy rates than the US are justified,” said Antoine Bouvet, a senior rates strategist at ING Groep NV. “This isn’t to minimise the challenge faced by the BOE. Clearly they’re facing an uphill battle to keep inflation under wraps with a more acute energy crisis than in the US, and with a delayed impact on inflation due to the energy price cap.”
While the BOE started its hiking cycle three months earlier than the Fed, it was quickly outpaced as US officials raised interest rates further and faster.
UK policymakers have since upped the ante, hiking by a half-point for the first time in more than 25 years earlier this month. Markets are betting they’ll continue to tighten policy by at least that amount in the next three meetings.
In the US, there are some tentative signs price pressures may be starting to slow. US inflation data for July came in lower than expected, with prices stable on a month-to-month basis.
With much of the upward pressure on prices stemming from power costs, the UK looks to be in a more severe predicament due to its status as a net energy importer and its proximity to the Ukraine war, which has upended supply dynamics in the region.
To be sure, the moves come amid thin summer markets where a lack of liquidity can enlarge swings in pricing.
Looking beyond the three-year mark, market-implied rates show the Fed’s key rate again nudging above the BOE’s. That likely reflects longer-term vulnerabilities in the UK economy that may force the BOE to ease policy, assuming inflation eventually turns lower.
“Unless wage growth and hence underlying inflationary pressures moderate on their own without a rise in unemployment, UK policymakers are stuck between a rock and a hard place,” said Mike Bell, global market strategist at JP Morgan Asset Management.
©2022 Bloomberg L.P.