Inflation fears hit UK markets as energy prices soar

Rising energy costs have spread fear among investors in recent weeks that inflation will not go away. One of the places where you feel the pressure most acutely is the UK, where the bond markets They showed some wild moves.

The most dramatic volatility has occurred with government bonds, whose coupons are linked to inflation. These bonds and derivatives known as swaps are seen as a measure of where investors think inflation is heading. Yields on them are at their highest levels in more than a decade.

It’s such an extreme, I’ve never seen anything quite like it,” said Bethany Payne, global bond portfolio manager at Janus Henderson. “What you see in the UK is a broad rise in inflation expectations.”

Inflation-linked financial instruments, as British government bonds are known, have indicated that the UK’s retail price index could jump to an annual rate of 7% by April 2022, according to Deutsche Bank.

The interest rate on one-year inflation swaps jumped to 6.27% earlier this week, up from 5.77% last week, the highest level since at least 2005, and approaching Thursday. The three-year inflation swap rate also jumped, close to 5% in daily trading.

The sharpness of the movements indicates that some investors may have had to sell as positions reached automatic sell orders known as stop losses, according to traders. There has also been a sudden surge in demand by market players to use swaps to hedge the risk of higher inflation.

The UK is a more serious case of the same trends driving inflation higher in the US and around the world: supply chain disruptionsAnd labor shortage and rising energy prices. US bond yields have also risen in recent days, albeit less dramatic than in the UK

The 10-year Treasury yield has seen a 0.03 percentage point rise this month so far at its highest point this week, before falling to 1.515% on Thursday. The equivalent denomination yield has increased more than fourfold in the same time frame.

UK problems driven Severe shortage of natural gasAs a result, energy prices rose to record levels. Energy issues have been amplified by the UK’s exit from the European Union, which has reduced the size of employment in the country. One visible effect of the labor shortage: a supply crunch at gas stations due to a shortage of tanker truck drivers.

said Jorge Garrayo, inflation and inflation analyst at Société Générale.

UK natural gas futures have doubled over the past month and are up nearly sixfold since the start of the year.

“To put things in context, considering the relative energy use in Europe for example, the higher natural gas prices seen this year equate to oil trading around $200 per barrel now,” said George Saravelos, global head of forex research at Deutsche Bank. He said that the importance of these moves in terms of inflation and growth should not be underestimated.

Inflation was already on the rise. The UK Consumer Price Index rose at an annualized rate of 3.2% in August, more than economists had expected. The retail price index, another inflation measure that the bond market uses as a benchmark, jumped 4.8%.

Certainly, some investors and economists have raised questions about whether forward-looking measures of inflation calculated from traded financial products such as swaps have the predictive value that many assume. but they They remain closely watched by investors.

The United Kingdom had A long history of annoying bouts of inflation, including long periods in the 1970s, and again in the early 1990s when the pound devalued, driving up import prices.

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The Bank of England has indicated in recent weeks that it is increasingly likely to raise interest rates in the near future, making it among the most hawkish central banks in developed central markets. The quantitative easing program is scheduled to end at the end of the year.

Some investors are betting that the central bank will have to move in raising interest rates sooner than previously thought to try to cool the latest jump in inflation. Targeting an annual rate of 2%.

“They’re going to have to be more reactive to this data, they can’t just sit back and look for a laissez-faire,” said Janus Henderson’s Ms Payne.

In anticipation, investors sold British government bonds with the yield on 10-year British Treasuries rising to 1.153% on Wednesday, the highest level since May 2019. Yields rise when prices fall. The move comes in part on the heels of a broader increase in government bond yields driven by expectations that the Federal Reserve will start reducing bond purchases from next month.

“Investors are demanding a higher premium for buying UK debt because they are concerned about how much of this fixed income will be eroded by inflation over time,” said John Reith, head of UK interest rate strategy at UBS.

write to Anna Hertenstein in anna.hirtenstein@wsj.com

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