Gilts fall as UK inflation runs ahead of BoE target

UK gilts dropped after data showed the country’s rate of inflation was running ahead of the Bank of England’s target, piling pressure on the central bank to rein in its pandemic-era bond-buying programme.

The yield on the 10-year gilt rose 0.04 percentage points to 0.673 per cent as the price of the government debt fell, while the pound strengthened against the dollar and the blue-chip FTSE 100 dropped.

The moves came after Britain’s inflation rate rose 2.5 per cent in the 12 months to June, in the third consecutive month of consumer price rises that were higher than economists had expected.

The BoE, which has increased its debt holdings from £645bn to £895bn since March 2020, was criticised last month by Andy Haldane, who recently left as its chief economist, for heading towards an “economic handbrake turn” if it remained relaxed about inflation.

BoE policymakers “will undoubtedly still insist price pressures will be short lived,” said John Wraith, head of UK rates strategy at UBS. “But the higher the rate goes in the interim, both absolutely and relative to their own forecast, the more that conviction will be undermined.”

The FTSE 100 dropped 0.5 per cent as shares in major exporters such as aircraft engine maker Rolls-Royce and fashion house Burberry fell. FTSE bank shares rose 0.5 per cent overall, however, as traders bet on the BoE moving closer to its first post-pandemic interest rate rise that would allow lenders to increase customers’ borrowing costs.

Derivative markets linked to the path of BoE rates on Wednesday priced in an increase in UK interest rates to 0.25 per cent by November 2022. Before the inflation data, such an increase was expected by May 2023.

Sterling gained 0.3 per cent against the dollar to purchase $1.3844.

Elsewhere the Stoxx Europe 600 share index dropped 0.3 per cent as traders stayed cautious ahead of potential new signals from the US Federal Reserve about monetary policy. Futures markets suggested Wall Street’s S&P 500 would open flat.

Fed chair Jay Powell will give his semi-annual report to Congress on Wednesday after data showed US headline consumer prices rose 0.9 per cent between May and June, exceeding economists’ forecasts with the largest monthly gain since 2008.

The price rises have intensified debate within the Fed about when to reduce the $120bn of monthly debt purchases that have boosted global markets since March 2020, although Powell has previously argued the inflation surge will be temporary.

“I would be very surprised if Powell said anything other than that he was waiting for substantial further progress [for the economy],” said Fahad Kamal, chief investment officer at Kleinwort Hambros.

Powell’s appearance before Congress comes after other central banks began winding down their emergency stimulus schemes.

New Zealand’s dollar rose 1 per cent against its US counterpart on Wednesday to 70.1 US cents after the Reserve Bank of New Zealand said it would halt its additional asset purchases by July 23 because economic activity had moved “above its pre-Covid-19 level”. The move follows similar decisions in Canada and Norway.

The yield on the benchmark 10-year US Treasury fell 0.02 percentage points to 1.391 per cent. Brent crude fell 0.8 per cent to $75.89 a barrel.