Gilts sink as traders rethink timing of interest rate cuts

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Gilts have endured a bruising new year as investors have a big rethink about the timing of Bank of England interest rate cuts this year.

An Ice Bank of America index of UK government debt has sunk by 3.6 per cent this month — more than double its US counterpart — with much of the damage done by an unexpected acceleration of inflation.

The surprise added to the uncertainty in global bond markets as central bankers on both sides of the Atlantic try to steer investors away from bets on rapid interest rate cuts this year.

January’s bond market sell-off comes on the heels of one of the sharpest two-month bond rallies for decades late last year, fuelled by slowing inflation and dovish comments on rates from the Federal Reserve and other central bankers.  

“The UK gilt market moved too far, too fast last quarter with significant short covering being one of the key drivers of the rally” said William Vaughan, associate portfolio manager at Brandywine Global, who added that the surprise inflation print this week caught “the now one-way positioned market off guard.”

While the UK’s annual inflation rate unexpectedly accelerated to 4 per cent in December, economic data has been mixed with retail sales data and wage growth this week both softer than the market had predicted.

Still, traders in swaps markets are betting that the UK will deliver 1.1 percentage points of interest rate cuts this year, from the current level of 5.25 per cent, a 15-year high. At the start of the year traders had priced in 1.73 percentage points of cuts.

“Given the uncertain message coming from the data with UK inflation remaining the highest among major economies and wages still growing at around 6.5 per cent year on year, a hawkish bias from the BoE is likely to remain in place for some time,” said Sebastian Vismara, financial economist at BNY Mellon…