UK gilts rose sharply on Monday as traders took advantage of comments made by a senior Bank of England official who suggested that the Bank may be prepared to consider lowering interest rates in mid-next year.
After Huw Pill said that market expectations of cuts starting next summer are not unreasonable, the yield on the two-year gilt, which is sensitive to interest rates, fell by 0.09 percentage points, reaching 4.62 percent, its lowest since June. Prices and yields are inversely related.
The swaps market now expects 0.75 percentage points in rate cuts for next year. This is up from a half percentage point at the beginning of the month as the market has shifted its expectations.
Investors are shifting their focus away from high interest rates needed to control global price pressures and towards the possibility of weaker economic expansion.
Pill, speaking after the markets closed on Monday night, said that the BoE may be in a better position to “consider” or “reassess”, its stance regarding rates by the middle of the next year, depending on the evolution of the economy.
Pill said that it is unlikely that anything will change in the next nine-months.
Daniela Russell is the head of UK rate strategy at HSBC. She said that Huw Pill’s dovish remarks overnight gave fresh fuel to gilt rally and caused the market to further price in rate cuts.
She added, “It was surprising to hear him confirm market expectations of cuts by the middle of the next year. It marks a shift from the narrative of higher wages for longer that we had heard until then.”
The benchmark 10-year gilt yields dropped 0.11 percentage points to just under 4.27 percent on Tuesday, the lowest since September. Sterling fell by 0.6 percent against the dollar, to $1.226.
The price of government bonds in the US and Europe has risen sharply during the last week, following a series of economic data that were weaker than expected and a downgrade to the BoE growth forecasts.
Benchmark US Treasury yields fell 0.28 percentage points in the last week, the largest weekly drop since the collapse Silicon Valley Bank.
Lyn Graham Taylor, a Rabobank rates strategist, said that global yields had been moving in tandem since Friday’s payroll figures. He said that the variations on a theme were: “We had a massive demand for bonds on Friday; a unwind on monday and a little bit more today.”
The official figures released by Germany on Tuesday show that industrial production declined for the fourth month in a row in September. This brings the third-quarter output of the sector to a total of 2.1 percent, adding to the woes in Europe’s biggest economy.
The yield on the 10-year Bund — the benchmark yield for the eurozone – fell by 0.06 percentage points to 2.68 percent on Tuesday.
The swaps market has now priced in all the rate cuts that the Federal Reserve Bank and the European Central Bank will make in June of next year. The UK’s rate cut for August is fully priced in.
Megum Muhic is a senior associate strategist with RBC Capital Markets. She said, “The UK has been playing catch up in pricing in rate reductions for next year. The global narrative over the past week has shifted to a weaker outlook on growth.”
Central bank officials have stated that they expect to hold rates for a long time as it fights inflation. However, the exact duration of this period has not been specified. The central bank warned last week that the UK economy would stagnate next year and warned of the risks associated with inflation.