GBP Swaps: Inflation overshoot puts pressure back on BOE

BOE MPC Bailey May 2022
Bear-flattening and gilt underperformance followed today's UK inflation overshoot with SONIAs down 20 ticks and the curve now pricing 5% BOE rates.

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  • Persistent inflation puts pressure back on over-optimistic BOE

  • BNPP: Still just one more hike


    Persistent inflation puts pressure back on over-optimistic BOE

    King Charles’s coronation may only be a little over two weeks away but the Keeper of the Privy Purse, Sir Michael Stevens, may have to check his costings again, judging by the latest inflation data. Core CPI printed 20bps above the Bloomberg consensus at 6.2%, headline CPI beat by 30bps at 10.1% and RPI also exceeded forecasts by 30bps at 12.6%, with the RPI-CPIH crevasse unchanged at 460bps.     


    The gilt opened 70 ticks lower after the data but continued its slide to break below 100 and eventually headed for the close around 99.92, down 1.3 points on the day in above-average volume of 222K. Spreads to 10y Bunds widened by 7bps as gilts underperformed, even as global fixed income was dragged down by the UK. Gilts bear-flattened as shorts bore the brunt of the selloff and BOE rate hike expectations repriced.


    Indeed, after opening 8-12 ticks weaker, SONIA futures also continued their fall after failing a sustain a fleeting half-hearted rally following the US open. Back white SONIAs and all the reds fell by 17-21 ticks with volume in Jun23 above 80K. SONIA MPC forwards now imply three more 25bps hikes and a peak for BOE rates of around 5.02% in Sep23.      


    For the inflation market, RPI resets were only trading today's fix about 5bps above the Bloomberg consensus and, as with SONIA, the front end of the inflation swap curve kept rising through the day to end +18bps in 1y RPI at 4.17% and +7bps at 4.16% in 2y RPI. Further out, 30y cash breakevens widened by 4bps with the IL45 syndication on the horizon and 30y real yields rose by 5bps to 0.74% having been as low 28bps in early April.     


    Reviewing the inflation data (and sticking to its forecast of a 25bps hike next month), Barclays noted that the unexpected strength of inflation in the February and March CPI prints relative to the Bank’s February forecasts came from both food and non-energy goods. In contrast, the developments in services (which the BOE “ considers the best representation of domestically generated inflation,” according to Barclays) have “not been a surprise,” to the BOE. Core services in March were broadly in line with, if not slightly below, February MPR expectations, Barclays reckons.


    Along the curve, despite the short end leading the selloff, gilts 2s/10s rose off early flats to finish at 4.1bps (-2.9) while 5s/10s also recovered to 14.5bps (-2.0). An auction of £3.75bn 4.125% 2027 gilts was covered an acceptable 2.46 times at 4.039% and an additional £492m of the gilt was taken down at the PAOF although the bond eventually finished the day cheaper at around 4.07% - in line with the curve although the 3y to 4y area generally cheapened most on the day as the supply landed.


    Finally gilt asset swaps were little-changed at 29.2bps (-0.1) in 5y and -58.2bps (-0.1) in 30y but fell to -15.0bps (-1.1) in 10y, close to their recent low.


    BNPP: Still just one more hike

    “One more hike in May” is the takeaway from BNP Paribas’s latest sterling rates research, with the bank now looking for rates to peak at 4.50% in the wake of today’s inflation surprise.


    “Incoming economic data (inflation in particular), evidence on credit conditions and the monetary policy committee’s forward guidance all suggest that the MPC’s work is not yet done,” reckons BNPP. And it sees the MPC keeping Bank Rate at 4.50% over the remainder of 2023, with cuts “only materialising next year, once inflation is closer to the 2% target.”


    What does that mean for rates further out the curve? BNPP continues:


    “We tweak our gilt yield forecasts, nudging up end-2023 2y by 5bp, while revising our 10y year-end forecasts to 3.35% for 2023 (+10bp) and 2.8% for 2024 (-5bp). We also look for a slightly flatter gilt 10s/30s curve this year than we did before. We maintain our 30y gilt-Bund spread tightener, and await better entry levels to establish trade ideas reflecting our views on real yields, the 30y swap spread and a gilts 10s30s flattener.”