Investors Bet Bank of England Will Cut Rates Below Zero by Early 2021

(Bloomberg) --

Investors have begun betting that the Bank of England will join the European Central Bank in cutting interest rates below zero.

Traders bought more than 21,000 option contracts in the past month that will pay out if the BOE delves into negative territory by March 2021. The bets will succeed if the central bank buckles under the twin pressures of Brexit and a global economic slowdown and eases policy to spur growth.

The BOE kept its benchmark rate steady at 0.75% last week and said it was less optimistic than usual about the economic outlook, citing risks tied to Britain's plan to exit the European Union by the end of October.

The option trades reveal speculation that Britain is heading for recession that would force the bank's hand, dragging down bond yields and fueling a rally in gilts. Sub-zero cuts would bring the U.K. more in line with the euro zone, Switzerland and Japan. The positioning stands in contrast to BOE Governor Mark Carney's recent comments that the effective lower bound for U.K. interest rates is close to, but a little above, 0%.

Talks between Britain and the EU are deadlocked after Prime Minister Boris Johnson sought to renegotiate the current deal. Brussels refused, heightening fears of a no-deal departure and its effect on the U.K. economy.

“Unless someone blinks, or Parliament finds a way -- including an election -- to reverse course, then we are heading for a hard Brexit,” Jim Reid, the global head of fundamental credit strategy at Deutsche Bank AG, wrote in a note.

The number of outstanding option positions based on short sterling futures contracts expiring in one to two years time, which assume sub-zero rates, stands at 21,300, according to data from the ICE exchange. That compares with total bets on BOE rate reductions of all sizes by March 2021 at 1.1 million. Money markets are pricing a full 25-basis-point cut by March 2020, and another 11 basis points by the end of next year.

To contact the reporter on this story: James Hirai in London at jhirai3@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, William Shaw, Anil Varma

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