The Bank of England and the Bond Market

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When the BoE’s monetary policy committee sits down to discuss the economy, it does so in the knowledge that the bond market does not think it is doing its job properly. Dan McCrum says if inflation hawks reveal themselves, markets may have to reassess.

UK inflation was steady in March, according to data released Tuesday, ticking along at what is the fastest pace in more than three years, as the effect of a weaker pound feeds through into import prices, all as might be expected. But when the bank of England’s monetary policy committee sits down next month to discuss the economy, its members will do so in the knowledge that the bond market doesn’t think that they are doing their job properly. Investors can trade bonds and financial contracts tied to the level of inflation. And over the next decade, the so-called breakeven rate for retail price inflation is 3.5%. The figure is also pretty similar for breakevens ranging from five to 30 years time. For such bets to pay off, inflation needs to be on average higher than the breakeven rate. The measure of inflation used here, which includes housing costs, tends to be around a percentage point higher than the consumer price variety policymakers target. Even so the implication is inflation will be seriously higher than 2% all the way to 2027. That’s going to require a series of letters to the treasury explaining why the target is being missed. Now look at market prices another way. And the inflation adjusted all real 10-year interest rate for the UK economy is minus 2.4%. That’s the lowest it’s been in, at least, 25 years. At a moment when the country is approaching full employment, an inflationary pressure from import prices is rising. Monetary policy is extremely stimulative. What is strange, however, is that many investors and strategists say that they share the view of policymakers, that import inflation will prove temporary. So we should look through it.

 

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