Government bond markets sell off as traders increase bets on rate hikes

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A sharp sell-off swept through global bond markets on Thursday as investors reacted to signals that central banks in the UK and eurozone are stepping up their inflation-fighting efforts.

The Bank of England triggered a sharp fall in Britain’s public debt when it raised interest rates for the second straight meeting, with a sizeable minority of rate setters voting for an aggressive half-a-half hike. -percentage point borrowing costs.

As the move ricocheted through markets around the world, the European Central Bank dealt a second blow by refusing to rule out a rate hike this year as it also battles soaring inflation.

“Central banks got inflation wrong and now they have to catch up,” said Mark Dowding, chief investment officer at BlueBay Asset Management. “In doing so, financial markets don’t like what they hear.”

Bond yields, which rise as prices fall, have soared. The UK 10-year yield rose 0.12 percentage points to 1.37%, the highest level in more than three years. The equivalent German yield, a benchmark for assets in the eurozone, climbed 0.11 percentage points to a nearly three-year high of 0.14%.

US government bonds were swept away by selling, with the 10-year Treasury yield rising 0.07 percentage points to 1.83%, close to a recent two-year high.

The BoE’s decision to raise interest rates by a quarter point to 0.5% was widely anticipated by markets, as the central bank tackles the highest inflation rate in the UK in 30 years. But the four votes for a bigger decision in the BoE’s nine-member rate-setting committee caught many investors off guard. Traders raised their bets even more on a series of further rate increases to follow.

Markets are now pricing in an increase of at least 1% by May and 1.5% by November, compared with expectations for August and March next year ahead of Thursday’s meeting.

“It looks like the rate hikes will be bigger than the market expected,” said Howard Cunningham, portfolio manager at Newton Investment Management.

The BoE also said it would begin the process of unwinding its debt purchases by not reinvesting proceeds from maturing bonds it holds in its portfolio.

The ECB’s decision to keep rates at a historic low of minus 0.5% was also in line with expectations. But markets were rattled by the ECB president’s departure from her previous insistence that the 2022 rate hikes were not in line with central bank guidance. Some analysts have likened this to a change in monetary policy in the United States late last year, when the Federal Reserve abandoned its longstanding message that inflationary pressures were transitory.

Markets now expect the ECB deposit rate to climb to minus 0.1% by the end of the year.

“President Lagarde at today’s press conference clearly signaled a pivot” towards more active monetary policy and “the transformation of the ECB into a living central bank,” said George Saravelos, global head of policy. currency research at Deutsche Bank.

Riskier eurozone government debt was hit by an even bigger selloff, pushing the yield on Italy’s 10-year bonds up 0.23 percentage points to 1.64%, the highest since May 2020. ECB policy played a key role in narrowing the gap between yields in Germany and indebted eurozone members on the bloc’s ‘periphery’, exemplified by the promise made by Lagarde’s predecessor , Mario Draghi, to do “whatever it takes” to save the euro.

Salman Ahmed, global head of macro at Fidelity International, described Lagarde’s message at Thursday’s press conference as a “reverse Draghi moment”.

“He called the shots and the markets lined up, while Lagarde decides not to push back market prices,” Ahmed said.

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