Pray for gilt traders

Back in the financial crisis, Morgan Stanley’s analyst Andrew Sheets drew the above cartoon to show how tough things were for bond traders at the time.

It came to mind looking at the market reaction to a third consecutive upside surprise in UK inflation, which has probably caused some gilt traders to evacuate their breakfasts this morning.

Moves this severe have probably been exacerbated by –cough- technical factors. It wouldn’t be surprising if some macro shops have had a very bad day today.

Ten-year gilts haven’t been quite as queasy, but yields have shot up 12 bps today to 4.28 per cent, the highest since last autumn’s omnishambles.

The UK seems to have a longstanding problem with structurally higher inflation than many other G10 countries, which is beyond our remit to diagnose right now. But in the near term, inflation readings like this obviously ramp up pressure on the Bank of England.

JPMorgan’s Allan Monks points out that UK inflation looks like it is increasingly domestically generated, and raises the possibility that the Bank will have to restart rate increases in 50 bps increments.

This is the third consecutive large upside surprise in the inflation data, and comes at a time when commodities have been falling. The scale of the April surprise is unlikely to be repeated next month. But it cannot be described as a one-off or simply as an indirect by-product of food and energy price gains, as the BoE and the doves have tended to suggest up until very recently.

. . . We think there is a good case for the BoE to consider a 50bp in June. The BoE is concerned about the lagged impact of past tightening, and stepped down the pace in March. But there appears to be a concerning interaction between wages and prices — an upside risk in the BoE’s forecasts — and the Bank should try to get ahead of this with clearer signs in the data that this risk is now crystallising. It is important to move quickly given the muted speed of transmission from higher rates into the mortgage market, and then absence of another shock that will prevent this dynamic from persisting.

. . . We assume the BoE won’t go 50bp in June, even though it probably ought to. But if this is to change we would expect some clearer signalling from Bailey. For now we expect the BoE to hike 25bps in June, and then as it makes another inflation forecast upgrade in August we expect this to prompt a further 25bp move up to 5%.

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