UK bond yields soar as markets brace for interest rate rise

Expectations jump after Bank governor says action will have to be taken to curb rising inflation

Expectations that the Bank of England will raise interest rates as early as next month jumped in the City on Monday after the governor said it would have to act to curb rising inflation.

The yield, or interest rate, on the UK’s two-year government bonds jumped to its highest level since May 2019 as traders anticipated a rate rise.

The two-year gilt yield jumped as high as 0.75%, up from 0.57% on Friday night, as a UK government bond selloff drove short-term borrowing costs to their highest in nearly two and a half years.

Yields rise when bond prices fall. Rising yields suggest investors are pricing in higher interest rates, from their current record low, to curb inflation.

Markets graphic

Andrew Bailey said he continued to believe the recent jump in inflation would be temporary, but he predicted that a surge in energy prices would push it higher and make its climb last longer, increasing the expectation of higher medium-term inflation.

“Monetary policy cannot solve supply-side problems – but it will have to act and must do so if we see a risk, particularly to medium-term inflation and to medium-term inflation expectations,” Bailey said on Sunday during an online panel discussion organised by the Group of 30 consultative group.

“And that’s why we at the Bank of England have signalled, and this is another such signal, that we will have to act,” he said. “But of course that action comes in our monetary policy meetings.”

By Monday afternoon, the money markets were pricing in an 85% chance of a rate rise from 0.1% to 0.25% at the Bank’s next monetary policy meeting in early November.

Traders see borrowing costs rising again next year, to 0.5% by February and to 1% by August, according to the latest pricing.

Inflation graphic

Analysts at Goldman Sachs predicted that the Bank would raise rates in November, February and May. “Recent BoE commentary combined with a shrinking activity shortfall, a resilient labour market and a likely further rise in long-term inflation expectations, suggests that the BoE will start hiking this year,” they wrote.

The Bank has forecast that the UK’s inflation rate will rise above 4% by the end of the year, more than double its target, as the world economy reopens from its Covid-19 lockdowns, causing shortages of supplies and staff, and the price of energy soars.

Bailey said demand for workers in the UK had been stronger than expected and the number of younger and older workers leaving the labour market had grown. “I do have concerns about labour supply growth,” he said.

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But he said he did not believe there was a “general pattern of labour market pressure” as wages climbed strongly in some sectors but less so in others.

He also said there were lessons for governments seeking to prevent future supply chain shocks in the way financial regulators had responded to the shock of the global financial crisis of 2007-09, including regular stress tests.

“I’m not saying we have the magic answer to supply chains across the board, but I think there are lessons that we have learned, in terms of resilience, that can usefully be adapted and used and translated into some other markets, particularly for instance when I look at energy supply,” he said.

Contributor

Graeme Wearden and agency

The GuardianTramp

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