Andy Bruce

LONDON (Reuters] – Britain’s government bond markets are showing signs of strain due to the country’s energy crisis. News headlines concerning gas prices sparked heavy selling this week – a development which points towards growing anxiety over inflation expectations.

Recent chaos in Britain was caused by a shortage of truckers, which left fuel pumps empty across the country. Additionally, energy companies were forced to declare bankruptcy due to a rise in European wholesale prices.

Investors chose the 2 trillion pound ($2.7 trillion gilt market) to be the most heavily traded among all major government bonds, just as Boris Johnson, Prime Minister of Boris Johnson, denied that the country was in chaos.

On Wednesday, the 10-year gilt yield (which moves in the opposite direction to the price) reached 1.152%. This was after the British wholesale gas contract for day ahead delivery exceeded 3 pounds/therm.

Jusqu’a week ago, gilts moved as usual in response to Bank of England comments about the economic outlook and economic data.

On Tuesday, a Bloomberg headline on rocketing British wholesale gasoline prices at 1345 GMT provoked rapid selling.

In a matter of 10 minutes, the 10-year yield rose by more than 2 basis point – equal to the movement that followed last month’s BoE policy announcement.

A new headline from Reuters about gas prices prompted further selling.

Peter Chatwell from Mizuho International’s multi-asset strategy said that there was “discomfort among gilt investors who were not well positioned to take advantage of the BoE interest rate rise this year.”

Chatwell stated that “all this comes down to the repricing, which takes place at the very forefront end of the curve — so there is the possibility for a hike within just under one month.”

“That is the tough thing for the market, and it’s why it’s linked to very immediate developments in energy prices.”

The BoE is likely to be interested in the recent changes to gilts. Officials want to evaluate the economic impacts of widespread supply disruptions, labour shortages, or a weakening energy market.

Some policymakers fear that investors and consumers may lose trust in the central banks’ ability to manage inflation. As a result, higher interest rates could be possible even when the economy is slowing.

The inflation-linked gilt market in Britain suggests that retail price inflation will increase to about 7% by 2022. This is a measure of outmoded inflation but it’s still being used by utilities companies as a benchmark when calculating energy bills. It was last recorded at 7% in the 1990s.

Deutsche Bank Jim Reid (DE) Investment strategist said Tuesday’s 10 basis-point rise in British 10-year rates breakeven rates, another indication of market inflation expectations for the long term, was “incredible”.

Financial markets estimated that there was a 90% chance of a BoE 15-basis point increase in interest rates before the end of this year.

BOE PUSH BACK

Officials at the BoE are interested in the recent swings of gilt prices. They are currently monitoring the function of the gilt markets ahead of completion of their 875 billion pound bond purchase programme, which is scheduled to end this year.

Before the Oct. 27 update of the public finances, the government will be closely monitoring the gilt markets. This is after Britain has borrowed over 320 billion pounds to help pay for the COVID-19 pandemic response.

A lack of clarity about the outlook indicates that a return in calm might not be possible.

Peter Schaffrik from RBC Global Macro Strategy stated, “The inflation that we are currently experiencing is clearly for real. But nobody really knows how many bottlenecks will persist, how long they will last, and how long the commodity prices will go up, etc.”

Chatwell, Mizuho’s Chatwell said that it is possible for the BoE to try and steer the market away form its excessively aggressive pricing of rate increases in the next weeks.

Chatwell said, “That might be where less hawkish rhetoric could come to fruition, in order to give some more clarity.” Chatwell stated that they would have to do so by Nov. 4, at the latest.

($1 = 0.7380 pounds)