GBP Swaps: Inflation prints bull-steepen as market mulls 25 or 50

•  Inflation prints bull-steepen as market mulls 25 or 50

• BNPP: Wage acceleration offsets CPI slowdown

• New issues: Another FRN makes it £2.5bn this month

Inflation prints bull-steepen as market mulls 25 or 50

Gilts held on to most of their opening gains after CPI and RPI inflation printed about 20bps lower-than-expected before the open today. 2y yields fell by almost 20bps while yields further out the curve ended 10-15bps lower. Even underperforming UK stocks joined the party with the FTSE-100 gaining 1.9% (admittedly offset by a 1% fall in the currency) while 10y gilts crunched 17bps tighter against Bunds and 12bps against Treasuries. Indeed USTs were back to unchanged this afternoon and Bunds bear-steepened, making gilts’ strength across the curve even more notable.

SONIA forwards rallied by 6bps for the Aug23 MPC meeting rising to 25bps for Jun24, with the curve now pricing Bank Rate at about 5.38% in August and roughly a 50:50 chance of 25bps versus 50bps. Bank Rate then peaks at an implied rate of around 5.89% in Dec23, before falling back towards 5.19% by Dec24. A speech late in the day by the BOE’s Dave Ramsden arguably had greater implications for the long end after the Deputy Governor raised the prospect of accelerating QT but Ramsden repeated that further tightening would be required if inflation persists.       

Gilts 2s/10s steepened by 7bps, 5s/10s rose by 4bps and 10s/30s by 2bps. In the background the market digested £3.75bn 4.5% 2028 bonds with a fall in bid/cover to 2.19 and a slightly longer tail of 2.1bps. The bond rallied 17bps on the day but yields finished a few bps above the auction average.    

What did the inflation market make of data? The report showed a sharp fall in RPI inflation to 10.7% from 11.3%, and a smaller dip in core CPI inflation to 6.9% from 7.1%. RPI fixings fell by around 10-15bps - rather than the full 20bps miss - and swaps only dropped by 1bps to 5bps out to 10y, while the long end was little changed. Real yields fell by 11-14bps and almost kept up with the rally in nominal gilts beyond about 5y, with linker real yields now back below 1% across most of the curve, and barely above 1% around 25y.        

BNPP: Wage acceleration offsets CPI slowdown

Still, not everyone is convinced about the impact of the data on the MPC. Analysts at BNP Paribas, are sceptical that the report “materially” changes the picture for the Bank of England, for a number of reasons.

First, they believe it will take “much more than one negative surprise for the MPC to be confident that underlying inflation is sustainably turning down.” They add that services inflation remains “considerably” above the Bank’s expectations, even if headline CPI is now back in line with the MPC’s forecasts.

Second, they reckon that the improvement in core inflation was partly due to some “typically more volatile categories”, such as furniture.

Third, BNPP estimates that the “breadth” of inflationary pressures eased only marginally. “The share of the overall core inflation basket that is above the rate of core inflation is still well above what would be expected on the basis of its historical relationship,” they find.

Fourth, the MPC will look at the “totality” of recent data, and last week’s labour market figures raise questions about the durability of the decline in services inflation.

BNPP concludes: “While the data are encouraging at face value and mean that another 50bp hike at the August meeting is not a done deal, we think they still tilt the balance in favour of another 50bp move. We continue to expect a terminal rate of 5.75%, to be reached after a final 25bp hike in September.”

Similarly, the team at Barclays reckons that wage growth plus the limited progress on services inflation, the Bank of England’s preferred measure of domestically generated inflation, points to further monetary tightening. Consequently Barclays also retains its call for a 50bps hike at the upcoming meeting, even if the risks of a step-down to 25bp have increased.

New issues: Another FRN makes it £2.5bn this month

• National Bank of Canada this week sold a £100m 1y FRN due Jul 2024 at SONIA +50bps via Credit Agricole. The latest deal takes total issuance of sterling 1y FRNs this month up to £2.5bn across 10 issues.