GBP Swaps: A further 95bps of hikes to halt inflation's march?

Anchor holding for now

While the anchor holding inflation expectations in check looks to be slipping, it has yet to give way entirely. Despite RPI exceeding forecasts by  a chunky 30bps (and more for CPI), printing at 11.4% versus the 11.1% Bloomberg consensus, RPI 1y swaps rose by less than the overshoot to 4.20% (+19bps) and 5y swaps rose to 3.99% (+12bps) as only a portion of the beat was incorporated into the inflation curve.

Similarly, the nominal market moved to price in a significant BOE response to the data. SONIA futures plunged by 15-33bps in the whites and by 26-34bps in the reds in massive volume of up to 195K for the Sep23 contract. The SONIA curve now prices a peak for BOE Bank Rate of around 5.45% in Nov23, implying a further 95bps rise in the BOE's key rate from its current 4.50%.

Further out the curve, the gilt future’s path was a steady climb from opening lows to leave the contract heading for the close about 60 ticks in the red, having opened as much as 142 ticks down. In the meantime, the market digested £3bn in 2033 Green gilts with strong bid to cover of 3.02 at an auction this morning.

Similarly, the spread to 10y Bunds opened around a new wide of about 183bps but gradually tightened back to end at 174bps, still 5bps wider on the day.  

Gilts 2s/10s flattened by a big 18bps to -14bps as 2y yields surged by 23bps. 5s/10s flattened by 9bps and 10s/30s fell by 4bps to -33bps. Asset swaps mostly ended a touch richer with 10y at -14.8bps (+2.0) and 30y at -59.2bps (+0.8).

In contrast, SONIAs showed almost no recovery from their immediate post-data drop and look like finishing just a few ticks off the lows.

What will the BOE make of the data? BOE Governor Bailey, making his second public appearance of the week, was forced to rebut a suggestion that inflation was “marching upwards”. However, Total Derivatives estimates even at an accelerated pace, the simple real policy interest rate (RPI-Bank Rate) will only turn positive in about November 2023 judging by the RPI fixings market.   

Elsewhere RBC notes that the 50bps CPI beat was the third in a row and adds that today’s print also came in above the BOE’s recent 8.4% forecast. The bank continues:

“At the May meeting the MPC retailed a ‘soft hiking bias’ in their language but gave little guidance in terms of how they might respond were the incoming data to differ from the May MPR projections…The only guidance that the MPC did give at the meeting was they were looking at services inflation (as well as labour market tightness and private sector pay) for signs of ‘persistent’ inflationary pressure.

As the bank points out, CPI services inflation unhelpfully rose to 6.9%, from 6.6% in March, above the BOE’s forecast of 6.7%. As a consequence,

“The day after the Governor and Chief Economist spent much of the Treasury Committee (TSC) hearing defending the Bank’s forecasting record, CPI inflation is already 0.3ppts above the MPR  projections, CPI services inflation 0.2ppts above.”

And RBC reckons the UK’s inflation problem is increasingly home-grown and into its second round:

“What that also means is that while the MPC also spend much of yesterday’s TSC defending its record by reference to the shocks to food and energy prices the UK has experienced, its inflation ‘problem’ is increasingly domestic…The accusation therefore that can be levelled at the MPC is that they have, and continue to, underestimate second round inflation effects that are currently fueling domestic inflationary pressures.

It concludes that the data “probably removes any degree of debate around a further increase in Bank rate at the June MPC (currently our base case).” Meanwhile the market is pricing “even more than two full 25bps rate increases after that.”

New issues: BayernLB, Vodafone  

• BayernLB priced a £250m 3y Covered bond 5.125% due Jun 2026 to give gilts +90bps. Leads are BayernLB and NatWest (B&D).

   

• Vodafone plc priced two hybrids: a £500m 63.25y NC8.25 at 8.125% and a €750m 61.25y NC6.25 at 6.625%. Leads are BNPP, BofA (B&D), GS, MUFG, NatWest and RBC with books of £1.1bn and €1.8bn.