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Traders bet Bank of England will raise rates as soon as next month

Traders are betting the Bank of England will increase interest rates from record lows as soon as November after governor Andrew Bailey said at the weekend the central bank “will have to act” to keep a lid on inflationary pressures.

The latest signal from the BoE that tighter monetary policy is on the way sparked a sell-off on Monday in short-dated UK government debt, sending yields jumping higher. The two-year gilt yield climbed 0.15 percentage point to 0.72 per cent, the highest level in two-and-a-half years.

Investors have bet on increasingly aggressive rate rises since the BoE’s monetary policy committee said last month that lift-off from the current record low of 0.1 per cent was possible before its bond-buying programme expires at the end of the year.

Bailey’s comments on Sunday, in which the central bank governor said he was worried about the rise in medium-term inflation expectations, sparked even more dramatic moves in markets linked to BoE interest rates.

“MPC members have had plenty of opportunities to push back on what the market is pricing,” said Theo Chapsalis, head of UK rate strategy at NatWest Markets. “The market perceives that as reinforcing the hawkish narrative and throwing oil on the fire.”

Markets are now fully pricing in a rise in interest rates to 0.25 per cent at the BoE’s next meeting on November 3, with the chance of more tightening to follow before the end of the year. Rates will hit 0.5 per cent — the central bank’s threshold to begin unwinding its bond-buying programme — by February and 1 per cent by August, traders are betting.

Prior to the BoE’s September meeting, only a single increase from the current record low of 0.1 per cent was priced in by next summer.

Earlier this year, investors piled into so-called steepener trades, in which they bet that a return of growth and inflation would drive longer-dated bond yields sharply higher. Instead, Monday’s sell-off was focused on short-dated government debt, which is highly sensitive to interest rate expectations, while long maturity gilts, which generally reflect investors’ perceptions of longer-term growth and inflation dynamics, posted much more muted moves.

The scale of the move suggested that investors positioned for a steeper yield curve were being forced to throw in the towel, according to Chapsalis. “What you’re seeing this morning is an epic washout across steepener positions,” he said.

Ten-year gilt yields rose 0.07 percentage point to 1.16 per cent, but remain short of last week’s high of 1.21 per cent. The lack of a bigger decline in longer-dated gilts reflects some investors’ belief that a rapid series of rate increases could turn out to be a mistake that the BoE would eventually have to reverse, according to ING strategist Antoine Bouvet.

“It’s pretty aggressive from the BoE given the headwinds the economy faces this winter,” Bouvet said. “You would have monetary tightening on top of fiscal tightening and the hit to the consumer from higher energy prices. If they follow through with rapid rate hikes it could be seen as a policy error.”

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