Bond investors alarmed over UK economy turn to BOE for answers

Brussels

THE UK bond market is flashing warning signals to Bank of England (BOE) Governor Andrew Bailey ahead of the central bank's meeting this week.

While traders don't expect the BOE to alter monetary policy on Thursday, bets on easier funding conditions are building. Yields out to eight years are submerged below 0 per cent, a sign the market expects interest rates to follow soon, according to Luke Hickmore, a money manager at Aberdeen Standard Investments.

At the same time real yields, which strip out inflation, are hovering just above record lows. That's putting strain on savers and pension funds, while inflation expectations are rising even as the country grapples with a recession. Throw in a rise in corona-virus cases and the end of the Brexit transition period on Dec 31, and Dr Bailey faces an unenviable problem of how best to support the economy.

"It's not the sort of headache where an aspirin and a dark room will help," said Mr Hickmore, who prefers buying Canadian, Australian and US debt. "The market has now boxed in the BOE."

Traders in money markets are pricing in a 10-basis-point interest rate cut to 0 per cent by March, with BOE officials careful not to rule out a move into sub-zero territory. HSBC Holdings' Steven Major said the BOE could rely on the rhetoric of negative interest rates, without having to actually do so.

GET BT IN YOUR INBOX DAILY

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign UpVIEW ALL

Citigroup argues that the BOE could pave the way for negative territory by removing the guidance that the lower bound is "close to, but a little above, zero" at its decision.

Ten-year yields are likely to touch 0.05 per cent, with sub-zero rates "increasingly likely", the bank said in a client note. They were at around 0.07 per cent on Friday, with equivalent real yields hovering at minus 3 per cent.

Investors will also pay attention to Dr Bailey's economic outlook, given that coronavirus cases are picking up across the continent. More than four million people across a large part of northern England must now comply with tighter lockdown rules.

The Monetary Policy Committee "will be debating whether the recovery is V-shaped or turning pear-shaped", Jamie Searle, a strategist at Citigroup, wrote in a note to clients. Ten-year gilts "have likely not yet seen the low in yield". BLOOMBERG