Investors rush to buy British bonds as traders increase bets on the Bank of England cutting interest rates ahead of the US Federal Reserve. The official data showed that the US rose more than expected in march, which was a blow for US rate cuts.
The stock markets dropped and borrowing costs worldwide jumped as traders re-evaluated their rate reduction predictions.
The Fed is expected to only reduce interest rates two times instead of three this year.
Demand for short-term gilts was almost four times greater than supply. The figures were published just hours after the UK had sold £5bn.
Investors have been buying UK gilts in the billions since the first pandemic lockdown, which was triggered by recession fears.
Imogen Bachra is a rates strategist with Natwest. She said that recent demand for short-term bonds was driven by the expectation that UK rates will be cut before the Fed.
She said, “Investors who think the Bank can cut more quickly than the Fed or at a higher price than the market currently values.”
The traders now believe that the Bank of England is going to start cutting rates in August from 5,25pc, three months ahead of the Fed and one month behind the European Central Bank.
After figures showed that consumer prices increased by 3.5pc compared to the previous year, speculation is increasing that the US may have to maintain higher interest rates for longer.
Analysts predicted a 3.4pc inflation rate, but the actual number was higher than that.
The data confirms that the US has not cooled as much as policymakers would have liked, despite borrowing costs reaching their highest level in 23 years.
The monthly inflation rate remained unchanged at 0.4pc, contrary to expectations for a slight decline to 0.3pc.
Former US Treasury secretary Larry Summers stated that the unexpected jump in headline inflation rate raises the possibility of another increase in borrowing rates by America’s Central Bank.
He said to Bloomberg TV: “You need to be prepared for the possibility that next rates will move upwards, rather than downwards.”
The markets plunged after the release of the inflation data. The benchmark S&P500 fell 1pc, while the tech-heavy Nasdaq dropped 1.1pc.
The FTSE 100 in the UK ended the day down 0.3pc from its previous gains.
Megum Muhic is a rates strategist with RBC Capital Markets. She said that investors no longer believe the UK has an inflation problem.
The rate of inflation in the UK, at 3.4pc, is not much different from the US. However, it has fallen faster than anticipated and is expected to fall below Bank’s target of 2pc within months. This is due to a significant drop in energy costs.
Mr Muhic stated: “The UK Market had been trading for a long period of time with a narrative that people believed the UK had a sticky, idiosyncratic inflation problem. It was seen as an anomaly.
“Now it’s beginning to see inflation coming below expectations. In places like the US inflation has come above expectations.”
Observers believe that the Bank of England is unlikely to reduce rates before the Fed. This would leave Britain vulnerable to capital outflows in the event of a rate gap with other economies.
The markets, according to strategists at Pictet Asset Management, Candriam, and Jupiter Asset Management, are still undervaluing the likelihood of the Bank of England reducing its interest rates sooner and more deeply than other major central banks.
Fed Chairman Jerome Powell warned that the central banks risk being forced to delay their first interest rate cut due to stubborn inflation and strong economic expansion.