UK Bonds Rally as BOE Decision Prompts Paring of Rate-Hike Bets

Andrew Bailey during a monetary policy report news conference at the central bank's headquarters in the City of London, on April 30. Photo by Chris Ratcliffe /Bloomberg

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(Bloomberg) — UK bonds extended a rally as traders pared bets on Bank of England interest-rate hikes, after officials left policy unchanged and Governor Andrew Bailey said it was in a “reasonable place.”

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The UK’s two-year yield, among the most sensitive to changes in monetary policy, fell 12 basis points to 4.44%. The move picked up as Bailey said in a news conference there’s not much “monetary policy can do” to prevent oil-driven cost increases from affecting UK businesses and households.

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Money markets trimmed wagers on the extent of hikes this year given only one policymaker voted for an increase. They are now pricing in around 65 basis points — equivalent to two hikes and just over a 60% chance of a third, up from around 73 basis points prior to the BOE decision.

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“The MPC is preserving policy flexibility rather than signaling a definitive push toward rate hikes,” said Janet Mui, head of market analysis at RBC Brewin Dolphin. “Markets arguably may be too aggressive in pricing two to three rate hikes this year.”

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Longer-dated bonds also rallied, with 10-year yields down eight basis points at 4.99%. Earlier in the session, these yields were trading up to 5.09% — near the highest level since 2008 — as the potential for an escalation in the Middle East conflict drove Brent oil prices to a four-year high. 

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The BOE’s decision shows policy makers are waiting for further clarity on the endgame of the Iran war, as the central bank said the outlook for global energy prices is “highly uncertain.” It laid out three scenarios based on different paths for energy prices and second-round inflation effects, with all three suggesting that rates will need to rise.

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Still, Bailey said there was a good case for holding rates now, with the situation starting in a very different place to before the energy shock caused by Russia’s invasion of Ukraine in 2022. The bank was not giving a clandestine message that rates will rise, he added.

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For the BOE’s next meeting in June, traders pared bets on the likelihood of a quarter-point hike to around a 60% chance, compared to over 80% before today.

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“The MPC was less hawkish than expected,” said Daniel Loughney, head of fixed income at Mediolanum International Funds Ltd, adding that he favors exposure to long-dated gilts. “There is a lot of bad news priced in.”

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—With assistance from Will Standring.

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