Government short-term borrowing costs near 5%, surpassing levels seen during mini-Budget rout as investors prepare for base rate hike
- A 25bps hike to 4.75% is expected, but if CPI comes in high this could be 50bps
- Market pricing terminal rate of 5.7% but UBS say this is unlikely
Government borrowing costs have continued to climb in anticipation of another base rate hike when the Bank of England’s Monetary Policy Committee meets later this week.
Two-year gilt yields are now touching 5 per cent, having climbed more than 100 basis points in the last month alone, surpassing levels seen during the fallout of the mini-Budget chaos that saw the yield peak at 4.64 per cent.
Climbing 6bps to 4.98 per cent in early trading on Monday, the move cements expectations that the BoE will opt for another 25bps base rate hike to 4.75 per cent on Thursday.
Longer dated Government bonds are also trading lower, with five- and 10-year yields up 6bps and 5bps, respectively.
Governor of the Bank of England Andrew Bailey
With yields of 4.63 and 4.46 per cent, respectively, this suggests markets are anticipating that the base rate will remain higher for longer.
The BoE has already hiked base rate on 13 consecutive occasions as it attempts to tackle consumer price inflation, which remains both higher and ‘stickier’ than expected having recorded a rate of 8.7 per cent in April.
Two-year yields have continued to climb and are now higher than they were at the time of the mini-Budget crisis
Fresh inflation data for May from the Office for National Statistics on Wednesday will give further insight into how the hiking cycle has fared in tackling inflation.
Katharine Neiss, chief European economist at PGIM Fixed Income, warned that should be ‘punchier than expected’, it is ‘possible a 50bps hike [to 5 per cent] is in the frame’.
She added: ‘The recent data flow is in sharp contrast to what we are seeing in the US and the euro area, where both headline and core inflation are coming down.
‘The US is dealing with a too-hot labour market, whereas the euro area is still feeling the aftereffects of the energy shock as it ripples through other non-energy goods and services.
‘However, the UK is affected by both – a double whammy for inflation. All this suggests the UK has a bigger inflation problem than its peers, hence the run of further interest rate rises the market now expects.’
Government borrowing costs have been climbing continuously for some time as the level at which base rate will peak is consistently reassessed.
They were driven higher last week as ONS data showed unemployment falling and wages continuing to spiral.
The two, five and 10-year yields have risen 280bps, 243bps and 196bps in the last year.
Base rate hikes have led to mortgage costs soaring to what some fear are unsustainable levels, with the average two-year fixed mortgage rate now over 6 per cent
And those problems could deepen with markets pricing more pain to come and a peak base rate of 5.7 per cent by December.
However, analysts at UBS said this would amount to 118bps of hikes between now and the end of the tear and ‘looks excessive and is… far above our expectations’.
They added: ‘While we acknowledge the challenging inflation outlook in the UK (and globally), we see indications that wage and price pressures could start to ease gradually.
‘The BoE itself has repeatedly argued that the impact of past rate hikes is yet to hit the economy.
‘Against this backdrop, we currently attach a relatively low probability to a scenario in which the BoE extends its hiking cycle beyond September.’
