(Bloomberg) -- Inflation breakeven rates in the U.K. haven't rallied this hard since the end of 2016. They may be pricing an adverse outcome in the Brexit trade talks.
The five-year breakeven rate has surged 43 basis points this quarter to 2.93%, putting it above the past year's average. That is at odds with the pound, which -- despite its recent correction -- strengthened considerably since the end of June.
In general, the breakeven rate shares an inverse relationship with sterling, given that strength in the currency tends to damp imported prices and curbs inflation. The defiant increase in the rates in the face of the pound's resilience suggests that traders in the rates market are bracing for a possible collapse in the talks between the U.K. and the European Union. Such an outcome would knock the pound lower and stoke inflation since -- in the worst scenario -- supply bottlenecks may ensue.
The inflation market has historically been savvy in foreseeing outcomes. Breakeven rates collapsed in November last year ahead of the U.K. elections in December by unwinding the Brexit risk premium and invoicing strength in the pound that was predicated on a victory by the Tory party.
Whatever the outcome of the current talks, it is clear that inflation-breakeven traders are taking no chances.
NOTE: Ven Ram is a currency and rates strategist for Bloomberg's Markets Live. The observations are his own and not intended as investment advice.
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