Column-Sterling’s Struggle: Rates Rise, Bonds Break

Britain’s interest rate horizon has soared this week on the back of an alarming new reading of inflation that some say is casting the economy as an anomaly among Western nations – and yet the pound didn’t know whether to laugh or cry.

In contrast to its disastrous reaction to the ruins of the UK bond market surrounding the government’s budget farce last September, when it plunged to near pandemic record levels, the pound has so far held up well against a change. equally seismic in the government bond market, or gilts, this week.

As it lost ground to a resurgent dollar – which was infused by a mix of debt ceiling anxiety, hawkish Federal Reserve polling and AI momentum for tech stocks Americans – the British pound stagnated on the more telling euro cross rate and its headline index also held up.

On the other hand, the fact that it gained nothing on the euro despite a 30 basis point increase in the premium on 10-year gilt yields over German benchmarks was equally telling and brought many people to wonder if a risk premium of another kind was not reappearing.

Some believe it’s less of a ‘moron’s bounty’ tied to the policy mistakes of eight months ago and more of a longer-term inflation insurance bounty, at least partly tied to the structural impact of Brexit.

“It’s very bad news for a currency when a huge jump in anticipation of a more hawkish central bank fails to support the currency,” opined John Hardy, currency strategist at Saxo, referring to the jump nearly half a point in money markets’ assessment of the Bank of England’s maximum interest rates this week, to nearly 5.5%.

The UK faces supply shortages, particularly labor shortages, which are the main ‘gift’ of Brexit,” he said, adding that the resulting risk of stagflation for the economy continues to challenge fiscal and monetary policies.

Admittedly, April’s inflation data hit the UK debt market like a thunderclap.

Although the headline consumer price inflation rate declined to 8.7% from 10.1% in March due to lower energy prices, it is still much higher than expected and Core inflation rates hit their highest level in 31 years, at just under 7%.

What’s more, hopes of a return to single-digit headline inflation have been challenged by further cuts in the numbers.

The National Institute for Economic and Social Research (NIESR) has calculated that its “adjusted average” inflation measure, which excludes 5% of the highest and lowest price changes, has reached a new cyclical high of 10 .2%, compared to 9.9% the previous month.

“These numbers suggest that we have yet to see a significant turn in underlying inflationary pressure,” the NIESR concluded.

A major concern for many households is annual food price inflation, which is still around 20%.

Here again, Brexit seems to be coming back to the fore.

Leaving the European Union is behind about a third of the increase in household food bills since 2019, researchers from the London School of Economics and other universities said on Thursday.

The study found that between January 2022 and March 2023, the price of Brexit-exposed food products rose about 3.5 percentage points more than those that were not.


The full picture sent BoE rate expectations, gilt yields and the UK mortgage market into a tizzy – with two-year swap rates supporting mortgagee funding costs and mortgage pricing climbing drastically. around 50 basis points in a week.

The yield on 10-year gilts jumped more than 50 basis points to almost 4.4%, its highest level since the BoE was forced to intervene to buy government bonds following of the budgetary shock of last September and the bursting of the pension funds which resulted from it.

Deutsche Bank economists believe that the main reason for the relative resistance of sterling is that real UK inflation-adjusted yields have actually risen sharply relative to equivalent German yields.

Using real 5-year indexed bond market yields, that premium jumped nearly 40 basis points this week to its highest level since last October.

The big question is whether this buffer is again deemed necessary to keep the pound stable, due to political doubts, BoE commitment or even the effects of Brexit.

A further erosion of the competitiveness of the British economy, due to comparatively higher long-term inflation, is likely to shake a currency that was only rehabilitated this year in the eyes of many investors, when the economy surprised and defied forecasts of a deep recession.

Earlier this month, German firm Berenberg claimed that the pound had also benefited from the return of relatively pragmatic and centrist leaders to the helm of the two largest parties ahead of the 2024 elections.

“After six years of chaos damaging the UK’s reputation as a well-run advanced economy, this is welcome news,” wrote the bank’s economist, Kallum Pickering.

But the dynamics of inflation could still require more compensation.

“We don’t think such a cross premium (like the one in September 2022) will return to UK markets, but we think it’s more likely than not that the currency will start to weaken from now on if the repricing of nominal yields fails to keep up with the repricing of the inflation outlook,” Deutsche Bank’s Sanjay Raja and Shreyas Gopal told clients.

This article is originally published on

Beth Malcolm

Beth Malcolm is Scottish based Journalist at Heriot-Watt University studying French and British Sign Language. She is originally from the north west of England but is living in Edinburgh to complete her studies.