UK Bonds Lead Global Rally As Bets On Rate Cuts Next Year Build

The Bank of England (BOE) in the City of London, UK, on Wednesday, June 15, 2022. The Bank of England should prepare to end interest-rate hikes before a likely recession early next year, according to Tim Congdon, the veteran UK monetarist who was an early prophet of the global inflation shock. Photographer: Hollie Adams/Bloomberg

(Bloomberg) -- European government bonds led a global rally as investors bet central banks in the region will have to ease policy more aggressively than previously expected next year.

The yield on 10-year gilts fell as much as 18 basis points to 4.32%, close to breaching its lowest since September. The rate on equivalent Italian notes also plunged, sending the spread over Germany to 188 basis points, near its narrowest level in recent weeks.

The repricing comes after the Bank of England on Thursday held rates unchanged, adding that a “restrictive” policy stance would be needed “for an extended period of time” to curb Britain's rate of inflation. Traders responded by betting that will only increase the likelihood of deeper rate cuts eventually, as tighter policy takes a toll on economic activity.

Bank of England Keeps Rates Unchanged, Playing Down Talk of Cuts

The moves added to a rally that kicked off in the US on Wednesday, when the Treasury's quarterly issuance plans provided some respite for the battered bond market, with sales of longer-term securities slightly lower than expected. The gains held after the Federal Reserve kept rates steady for a second consecutive meeting.

“With the Fed and the ECB also firmly on hold, the global monetary policy tightening cycle looks done now,” said Henry Cook, senior economist at MUFG. “Our current view is that the first UK rate cuts will occur by next summer – slightly earlier than markets are currently pricing. We expect that cracks will emerge in the ‘higher for longer' narrative over coming months.”

Together, the moves signal a growing conviction among investors globally that interest rates have peaked, and that the focus may soon turn to monetary easing.

Bets on deeper cuts by the European Central Bank are also building, despite President Christine Lagarde and colleagues insisting that rates will remain high for an extended period. Investors see nearly 100 basis points of cuts next year, according to swaps pricing linked to central bank meetings.

--With assistance from James Hirai.

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