MUFG, a major Japanese financial group, has discussed the recent hawkish repricing of the Bank of England’s (BoE) rate hike expectations. They believe that the UK fixed income market sell-off, which began in mid-May, is extending into July. However, MUFG maintains that the yields are currently overshooting to the upside.
Rate Hike Expectations: MUFG notes that SONIA interest rate futures contracts are pricing in a policy rate close to a peak of 6.50%. The implied yield on the March 2024 contract reached a new high of 6.39%, jumping around 182 basis points since mid-May.
Growth Momentum: The latest UK PMI surveys for June signal a likely slowdown in growth momentum for the second consecutive month. However, the composite reading of 52.8 indicates modest growth. MUFG believes that these survey results won’t significantly alter the BoE’s near-term outlook for the UK economy, which has shown more resilience than expected earlier this year.
Economic Resilience and Inflation: The UK economy’s recent resilience, coupled with elevated inflation, has led the UK rate market to price in a more extended hiking cycle for the BoE. The significant rise in UK yields compared to other major fixed income markets has been supporting a stronger pound. However, the pound has lost some upward momentum in recent weeks, with EUR/GBP testing support between 0.85000 and 0.8550, and GBP/USD (cable) remaining below resistance from last month’s high around 1.2850.
Potential Triggers for Reversal: MUFG suggests that evidence of weaker UK inflation and/or activity data could be the main triggers for a reversal of the current upward trends in UK rates and the pound. The market should closely watch the upcoming UK economic data releases, such as the UK labour market report on July 11th, GDP report for May on July 13th, and CPI report for June on July 19th.
Expectation of Softening Trends: MUFG expects softer inflation and growth to emerge later this year, resulting in a correction lower for UK rates and the pound.
MUFG observes that the Bank of England rate hike expectations have continued to reprice hawkishly. However, the financial group believes that yields are currently overshooting. While the UK economy has shown resilience, and inflation remains elevated, MUFG points out that evidence of weaker inflation or activity data could trigger a reversal in the current trends. They expect a softening in inflation and growth later this year, which would result in a correction lower for both UK rates and the pound.