After Sunday’s warning from Andrew Bailey that the BoE would “have to act” over inflation, this morning’s CPI report will provide markets with breathing space.
The 2-year Gilt yield has leapt in recent days (0.73%, yesterday’s close). But the 30-10 year spread has dropped, to 0.22%. This is the smallest yield gap since December 8th 2008 – in the midst of the sub-prime housing crisis.
The BoE is threatening higher interest rates when 1) it is not clear how far inflation will really rise, 2) Covid-19 infections are palpably on the increase and 3) the Chancellor of the Exchequer is rightly taking a tough stance against spending bids from cabinet ministers (Justice, transport, business and foreign).
The recovery in tax receipts has been ‘swift’ – up 13.34% y/y in the six months to August. But the PSNB-ex needs to come down more quickly: the twelve month moving total (£230.97bn) will cause a major ruction in UK financial markets if the BoE follows through with its threat to sell gilts. Gilt markets will be watching closely, to see if Mr Sunak has the support of Mr Johnson, and prevails over recalcitrant ministers.
Summary
- Threat of higher rates persists
- But Covid-19 infections are rising
- Gilt curve flattens: all eyes on Sunak in battle with ministers
