UK Bond Yields Surge – Sterling Update

Here’s the latest currency news from our partner Moneycorp, to help you find out what your money is worth.

GBP

The recent jump in UK bond yields, fuelled by expectations that the BoE will be forced to raise rates to an even higher level to combat persistent inflation, has resulted in the UK being forced to pay a yield of almost 5.7% for £4bn of gilts earlier in the week. That represents the highest level for 2-year UK debt since the DMO (debt management office) was established back on the 1^{st of} April in 1998, although the DMO are no fools. In fact, the yield was the highest paid for any gilt since 2007. The yield on the UK 10-year gilt hit a whopping 4.7% just yesterday (Thursday). The surge in borrowing costs is making an ever-increasing dent into the government’s spending capacity, a position which will only deteriorate as the BoE raise rates further. Not great news for the Tories, as we edge closer to an election.

Talking of BoE rate hikes, market-implied expectations for further hikes have understandably been increasing at a rapid pace of late, with markets now expecting the BoE to have to raise UK rates from the current level of 5%, to as high as 6.5% by the end of Q1 next year, with some calling for rates to go even higher, maybe even to as high as 7%. Gulp. That would represent the highest level for UK rates for 25 years. In an interview with the BBC this week, BoE governor Andrew Bailey suggested that whilst he understood the difficulties that people faced, ‘this is how we have to get inflation down.’ Comments such as that are clearly helping to feed those increased market-implied rate hike expectations. In other news this week, leading UK banks have now been summoned to a meeting with the FCA to explain why the average savings rate offered is still below 2.5%.

Having initially declined on the prospects of higher rates increasing the chances of a UK recession, the pound has since stabilised and has almost regained all of its losses since the last BoE meeting. Indeed, GBP/USD moved to as high as 1.2780 at one point yesterday, which is getting remarkably close to the recent cycle high at just over 1.2800. Furthermore, GBP/EUR has now moved back over 1.1700, highlighting a broadly stronger pound. For now, it seems as though the potential for higher rates is winning the battle against recessionary fears in the UK driving a weaker pound, but sterling bulls will still need to move forward with much caution, given those ever-increasing risks of a recession.

EUR

The single currency has been edging lower over the past three weeks, with EUR/USD moving from a high of just over 1.1000, to around 1.0830, before a late bounce yesterday afternoon. That move can be partly explained by the weaker economic output among the region, which itself is raising increased concerns over the capacity for the ECB to continue to hike Euro area rates much beyond this month’s expected 25bps move. This is especially so, when you consider that both Germany and the region as a whole are teetering on a recession. The ECB continue to talk about higher rates, given persistent inflation, but those decisions are becoming more difficult to explain away.

That weak backdrop has continued throughout this week, with further softness emerging among the latest PMI data. Monday’s manufacturing PMIs saw German data slip to 40.6 during June, as demand evaporated. Anything below 50 is considered contracting for an economy, so a 40 reading is particularly weak-looking. The Regional data was only moderately better at 43.4. Whilst mostly above the 50 threshold, Services PMIs also mainly missed against expectations. The latest Retail Sales data also confirmed a lacklustre consumer, flatlining over the past month across the region, having been expected to have rebounded over the period. On the positive side, German Factory Orders declined at a slightly slower pace over the past month. Looking ahead, next week sees updates on inflation for both Germany and Spain. Back to the single currency, and the Euro currently seems to be losing out on future interest rate hike expectations, with both the Fed and BoE currently leading the charge.