It is hard to describe what has happened in the United Kingdom in the past few weeks. The announcement of the mini-budget, aimed at cutting taxes, triggered an earthquake on the UK bond markets.
As a result, the Bank of England (BOE) intervened by buying guilts (i.e., UK government bonds) at a time when it was preparing to unload bonds from its balance sheet. Fast forward a couple of weeks, and the mini-budget was completely reversed after the finance minister was sacked.
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Needless to say, the events did not go unnoticed. Financial markets pushed the hand of the government by sending yields higher and the pound lower.
And this brings us to today’s piece of economic data, which was just released in the UK. Inflation has reached double-digit territory, coming at 10.1% in September.
What worries is the speed of the rise and the broad spread among the classes of goods and services. The weak pound does not help, and so the BOE must act. But in doing so, it finds itself between a rock and a hard place because if it decides to go big at its November meeting, the move would be fatal to gilts.
Remember the dynamics here – higher interest rates trigger rising yields and a decline in bond prices.
Details of September UK inflation report
Both the CPI and the Core CPI exceeded market expectations. The CPI YoY reached 10.1% after 9.9% previously and 10.0% expected. Also, the Core CPI climbed at 6.5% YoY after 6.3% previously and 6.4% forecast.
Food prices contributed the most to the rise in inflation. Also, a weak GBP contributes to higher import prices, another dynamic that contributes to inflation.
In other words, there is no peak in sight, so the BOE should go big on its next move on interest rates. But judging by how the bond market reacted recently, the fear is that something is about to break should the BOE act bolder.
All in all, GBP traders should be aware of the potential rise in volatility around the time the BOE holds its November meeting. With this data and market, it has no easy job of delivering on its price stability mandate.
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