UK April’s Consumer Prices: Markets Abandon Hopes for a Linear Disinflation Path. UK April’s Consumer Prices: Markets Abandon Hopes for a Linear Disinflation Path. UK April’s Consumer Prices: Markets Abandon Hopes for a Linear Disinflation Path.

UK April’s Consumer Prices: Markets Abandon Hopes for a Linear Disinflation Path.

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:


- April’s inflation data show that the Bank of England's is not done fighting inflation. This is likely to result in a slower rate-cutting cycle than the markets had initially anticipated.

- While the BOE may follow the ECB in cutting rates this summer, both central banks will likely remain highly data-dependent. Hence, as the bear-flattening of yield curves concludes, it is probable that a bear-steepening will resume.

- Two-year yields are likely to rise to test 4.71% in the next couple of weeks. Ten-year yields may follow and test resistance again at 4.36%.


Falling gas and electricity prices led to a sharp decline in UK CPI numbers in April, with headline consumer prices increasing by 2.3% year-on-year, down from 3.2% in March. With inflation nearing the Bank of England's 2% target, policymakers might be tempted to consider cutting rates but will remain cautious about celebrating prematurely.

Despite the significant drop in headline consumer prices, the figures still exceeded expectations by 0.2 percentage points. At the same time, Core and Services CPI, remain persistently high at 3.9% and 5.9% respectively. Additionally, the average weekly earnings for the past three months have remained around 6% year-on-year. Thus, markets are quickly recognizing that the Bank of England is unlikely to embark on a swift and aggressive rate-cutting cycle, leaving monetary policy decisions data-dependent.

An ECB June rate cut might enable the BOE to cut rates in summer, too.

The UK and Eurozone economies are closely linked through trade and investment. Economic conditions in the Eurozone can spill over into the UK, influencing the BoE’s policy decisions. For instance, a recession in the Eurozone could dampen UK exports, prompting the BoE to consider rate cuts to support domestic growth. At the same time if the ECB cannot cut rates due to sticky inflation in the Eurozone, the BoE might face pressure to maintain higher rates to prevent capital outflows and currency depreciation.

As we anticipate the ECB to implement its first rate cut on June 6th, there is a high likelihood that the Bank of England will seize the opportunity to follow suit in summer. However, if inflation and wages in the UK remain persistently high, the BoE may be less aggressive in cutting rates compared to the ECB. The data-dependency of both central banks will contribute to rate volatility in the interim. Hence, once the period of bear flattening concludes, it is likely that bear steepening will resume.

Implications for UK Gilts

The reason behind today's bear-flattening of the yield curve is straightforward: markets anticipate that the Bank of England will cut rates less than expected, which could dampen the country's economic growth prospects. As a result, short-term yields are rising faster than long-term yields.

1. High-for-longer means that the bear flattening of the UK gilt curve will continue

The bear-flattening move that we are witnessing to today is likely to continue into June as the two-year Gilts are trading too rich relative to what bond futures are pricing the BOE to cut by the end of the year. The three-month SONIA future is pricing three rate cuts by the end of June 2025. Yet, the two-year Gilt yield at 4.35% is 90bps below the BOE benchmark rate of 5.25%.  As market assess the data dependency of central banks, they will come to the realization that interest rate cuts are not going to be fast and aggressive in the UK this year, pushing 2-year Gilts up to 4.71%.

Source: Bloomberg.

2. Long-term Gilts will remain volatile, but a rally is unlikely.

As the bear-flattening move of the yield curve reaches its limits, the focus shifts to the long end of the curve. For duration to perform well, a fast and aggressive rate-cutting cycle is needed. If this does not materialize, long-term yields are likely to continue trending higher, while the short end of the yield curve remains anchored, resulting in a bear steepening of the yield curve.

Given that inflation remains sticky, and UK economic growth is expected to recover this year, it is unlikely that the upcoming rate-cutting cycle will be aggressive. Consequently, 30-year yields may test resistance at 4.83%. If this resistance is broken, yields could rise towards their October 2023 peak of 5.2%.

Source: Bloomberg.

3. Cash bonds are likely to continue to outperform bond ETFs.

Until inflation remains sticky, bond ETFs are likely to underperform cash bonds due to their exposure to interest rate risk. Holding a cash bond allows an investor to keep the bond until maturity, thereby locking in the yield at the time of purchase. For example, investors who bought 2-year Gilts one year ago at a yield of around 4% per year would realize this yield if held to maturity. In contrast, a short-term Gilt ETF, which continuously buys and sells bonds to maintain its target duration, realized a lower total return of 3.15% over the same period (see table below).

Given the current volatility in the rates market, bond ETFs are expected to continue underperforming cash bonds as they adjust more frequently to changes in interest rates, impacting their prices and returns. 

Other recent Fixed Income articles:

17-May Strong trade-weighted EUR gives ECB green light to cut rates, but bond bull rally unlikely
14-May UK labor data and Huw Pill's comments are not enough for a bond bull rally
08-May Bank of England preview: Rate cuts in mind, but patience required.
06-May Insights into this week's US Treasury refunding: 3-, 10-, and 30-year overview
02-May FOMC Meeting Takeaways: Why Inflation Risk Might Come to Bite the Fed
30-Apr FOMC preview: challenging the March dot plot.
29-Apr Bond Markets: the week ahead
25-Apr A tactical guide to the upcoming quarterly refunding announcement for bond and stock markets
22-Apr Analyzing market impacts: insights into the upcoming 5-year and 7-year US Treasury auctions.
18-Apr Italian BTPs are more attractive than German Schatz in today's macroeconomic context
16-Apr QT Tapering Looms Despite Macroeconomic Conditions: Fear of Liquidity Squeeze Drives Policy
08-Apr ECB preview: data-driven until June, Fed-dependent thereafter.
03-Apr Fixed income: Keep calm, seize the moment.
21-Mar FOMC bond takeaway: beware of ultra-long duration.
18-Mar Bank of England Preview: slight dovish shift in the MPC amid disinflationary trends.
18-Mar FOMC Preview: dot plot and quantitative tightening in focus.
12-Mar US Treasury auctions on the back of the US CPI might offer critical insights to investors.
07-Mar The Debt Management Office's Gilts Sales Matter More Than The Spring Budget.
05-Mar "Quantitative Tightening" or "Operation Twist" is coming up. What are the implications for bonds?
01-Mar The bond weekly wrap: slower than expected disinflation creates a floor for bond yields.
29-Feb ECB preview: European sovereign bond yields are likely to remain rangebound until the first rate cut.
27-Feb Defense bonds: risks and opportunities amid an uncertain geopolitical and macroeconomic environment.
23-Feb Two-year US Treasury notes offer an appealing entry point.
21-Feb Four reasons why the ECB keeps calm and cuts later.
14 Feb Higher CPI shows that rates volatility will remain elevated.
12 Feb Ultra-long sovereign issuance draws buy-the-dip demand but stakes are high.
06 Feb Technical Update - US 10-year Treasury yields resuming uptrend? US Treasury and Euro Bund futures testing key supports
05 Feb  The upcoming 30-year US Treasury auction might rattle markets
30 Jan BOE preview: BoE hold unlikely to last as inflation plummets
29 Jan FOMC preview: the Fed might be on hold, but easing is inevitable.
26 Jan The ECB holds rates: is the bond rally sustainable?
18 Jan The most infamous bond trade: the Austria century bond.
16 Jan European sovereigns: inflation, stagnation and the bumpy road to rate cuts in 2024.
10 Jan US Treasuries: where do we go from here?
09 Jan Quarterly Outlook: bonds on everybody’s lips.

Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.