The UK yield curve bear steepens today with yields adding 4 bps (2-yr) to 2.6 bps (30-yr). The UK 2-yr yield added around 55 bps since the Bank of England switched positions at its August meeting. From that moment, the onus changed from keeping monetary policy very accommodative to enable inflation to rise to the 2% target over the medium term to applying some modest tightening in order for inflation to slow to the 2% target over that same policy horizon. Modest interest rate hikes are part of the plan and could even come before the BoE ends net asset purchases under its QE-programme and thus before the end of the year. That’s what markets have been discounting and could be derived from weekend comments by BoE governor Bailey and inflation hawk Saunders. The former warned on the potentially very destructive impact from persistent inflation pressure if the BoE doesn’t act. The latter aligns with market thinking about a 2021 inaugural rate hike. Sterling tested EUR/GBP 0.8472 support, but the move lacked dash. The range bottom of the sideways channel (0.8472/50) doesn’t seem like giving away that easily. GBP/USD tried to force its way above the recent intraday spikes just below 1.3650, but the move similarly lacked panache.
European yields maintained last week’s upward momentum as well. German yields add 1.5 bps (2-yr) to 2.9 bps (10-yr) across the curve. The 10-yr yield easily passed the June high (-0.15%) and has the 2021 recovery high for grabs (-0.07%). The European 10y swap rate currently trades above highly relevant technical resistance. A sustained break above the zone 0.21% (38% retracement 2018/2020 decline) – 0.23% (previous all-time low in 2016) – 0.24% (early 2020 high) would end the medium term sideways trading channel (-0.39%-0.24%) and set the stage for a new trading arena defined by the previous resistance as bottom and 0.59% on the upside (62% retracement on 2018/2020 decline). Oil price developments continue to play an influential role with Brent crude setting a new recovery high above $84/barrel before showings some signs of topping off. Key ECB policy makers (see below) for now don’t budge despite dangerous inflation developments. Today’s eco calendar wasn’t influential while the absence of US traders (Columbus Day) lowered trading volumes. European stock markets cede slightly ground, failing to build on last week’s comeback. The biggest victim on FX markets from rising interest rates is the Japanese yen. USD/JPY gains another big figure from 112 to 113, trading at the strongest level since 2018. EUR/JPY approaches 131.
Czech headline Inflation rose 0.2% M/M and 4.9% Y/Y (from 4.1%), the highest since October 2008. The rise is predominantly due to an unexpectedly sharp pick-up in core inflation and faster growth in food prices. Within core inflation, the cost of owner-occupied housing is an important factor. According to the CNB, the rise in costs ‘stems both from the domestic economy, which is characterized by a renewed increase in labour market tightness and a strong consumer appetite, and from abroad’. The CNB already responded to this risk by raising interest rates by 0.75% in September and will assess it comprehensively in the forthcoming autumn forecast. The initial reaction of the Czech krone to the data was modest, but the currency regained traction after the CNB comments with EUR/CZK currently trading in the 25.40 area. However, the key 25.25 area stays out of reach.
ECB’s Lane elaborated on the conditions that need to be fulfilled to raise the policy rate over time. With respect to the condition that “realized progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilizing at 2% over the medium term”, he mentioned the need to sharply differentiate between volatile components of headline inflation and persistent dynamics of underlying inflation. According to Lane, this approach also applies to wage rises. ‘In particular, a one-off shift in the level of wages as part of the adjustment to a transitory unexpected increase in the price level does not imply a trend shift in the path of underlying inflation’.