Surging UK Inflation Signals To Fed Watchers That Battle Against Price Hikes Isn't Over: UK Bond Yields Soar To 15-Year Highs

A hotter-than-expected inflation reading in the United Kingdom has thrown a cold shower on hopes that the fight against inflation is nearing an end.

In May 2023, consumer price inflation in the United Kingdom was 8.7% year-on-year, unchanged from the previous month but higher than market estimates of 8.4%. Monthly inflation increased by 0.7%, exceeding market expectations of 0.5%.

The underlying measure of inflation, which excludes energy, food, alcohol and tobacco, also surprised to the upside, accelerating from 6.8% in April to 7.1% in May and reaching the highest level since 1992.

Inflation in the United Kingdom peaked in October 2022 at 11.1%, but has subsequently fallen at a significantly slower pace than in the United States. After hiking rates by 25 basis points to 4.5% in May 2023, the Bank of England forecasted inflation lowering to 5.1% in Q4 2023, and meeting the 2% target by late 2024. Following the latest CPI data, the risk is that the path back to the 2% target will be further prolonged.

Chart: Rising UK Core Inflation Tells That Price Pressures Extend Beyond Energy and Food

Traders Expect Stronger BoE Hikes, 2-Year Gilt Yields Jump To July 2008 Highs

In response to the unexpectedly high inflation reading, traders upped their expectations for additional interest-rate hikes by the Bank of England, and now anticipate a 50% likelihood of a half-point hike at the upcoming meeting on Thursday. The market is fully pricing in UK interest rates to rise to 6% by December 2023.

The yield on 2-year gilts, which is seen as a barometer of market-rate expectations, has skyrocketed above the 5% mark, jumping to the highest level since July 2008.

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Chart: UK 2-Year Yields

Fed Is Now On Alert: Powell Testifies Before The Congress

The Fed may take note of the recent reacceleration of inflation in the United Kingdom as a reminder that the war against inflation is not over yet.

Bond speculators also upped their expectations on a fresh rate hike by the Fed in July, now assigning 79% chance to this outcome, up from 62% a week ago.

Treasury 2-year yields ticked 4 basis points higher to 4.73%, recovering more than half of the drop posted on Tuesday. The rise in short-term yields is likely to result in a negative session for the Ishares 1-3 Year Treasury Bond ETF SHY.

Fed Chair Jerome Powell will testify before the House Financial Services Committee on Wednesday and the Senate Banking Committee on Thursday.

Read now: Powell To Testify Before Congress After Fed Pause: What The Market Is Watching For

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