Wednesday May 14, 04:49 PM
UK gilts slump after BoE ramps up inflation forecast; European bonds down
LONDON (Thomson Financial) - UK gilts slumped after the Bank of England ramped up its inflation forecast in its latest quarterly Inflation Report, dampening prospects that interest rates will fall as quickly as markets hope.
The BoE warned that inflation could rise to near 4 percent by autumn if interest rates fall in line with market expectations, killing off hopes that the central bank will be able to accelerate cutting interest rates in the face of deteriorating economic growth.
'A June cut now looks pretty unlikely and any further loosening will be modest in the foreseeable future,' said Jonathon Loynes, chief European economist at Capital Economics.
In its quarterly Inflation Report, the central bank said its base case scenario is that the annual CPI (NYSE: CPY - news) inflation rate will likely hit 3.6 percent this autumn if interest rates fall in line with market expectations.
However its fan chart showing the range of forecast probabilities suggests there is a real risk inflation could rise beyond 4 percent.
If interest rates remain at 5.00 percent though, then the BoE expects inflation to fall to the 2.0 percent target, while GDP growth would fall below 1 percent this year and only recover to just above 2 percent in two years time.
This suggests not only that interest rates are unlikely to fall next month, but that there will be far fewer cuts than markets had hoped this year, possibly none at all.
'The market, having been generally more dovish than us, has now swung to become more hawkish with not even one cut fully priced before year end,' said Daragh Maher, strategist at Calyon.
Elsewhere, European bonds were also lower on continuing inflation concerns in the euro zone, and as risk appetite picked up on equity markets to the disadvantage of safe haven assets like fixed income bonds.
Risk appetite picked up after CPI inflation in the United States rose at a slower-than-expected pace in April of 0.2 percent, while core inflation rose just 0.1 percent.
However, though markets cheered the benign CPI data, analysts cautioned that inflation is unlikely to remain subdued in the world's largest economy for long given that oil prices are well above $125.
'March's bellow-consensus CPI report gave a boost to Treasuries, but its longer-term significance is questionable,' said Meny Grauman, economist at CIBC World Markets.
'Inflation remains a persistent threat to the US, and it is unlikely that a mild economic slowdown will change that,' said Grauman.
At Yield Change on
1521 GMT pct previous close
June euribor future (Liffe) 95.17 dn 0.02
Sept euribor future (Liffe) 95.27 dn 0.04
GERMANY
June bund future (Eurex) 113.71 dn 0.64
4.00 pct Jan 2018 govt bond 98.66 4.17 dn 0.61
FRANCE
4.25 pct Oct 2017 govt bond 97.00 4.38 dn 0.58
ITALY
4.50 pct Feb 2018 govt bond 99.49 4.62 dn 0.50
UK
June gilt future 107.35 dn 0.83
5.00 pct March 2018 govt bond 101.40 4.82 dn 0.87
June short sterling future 94.15 dn 0.08
Sept short sterling future 94.21 dn 0.14
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