Market News

By Alice Gledhill

(Bloomberg) -- UK government borrowing costs rose toward the highest level in decades relative to Germany’s, spurred on by the latest evidence of inflationary pressures dogging the economy.

The spread between UK and German 10-year yields widened to as much as 228 basis points. If sustained, that would be the largest gap on a closing basis since the early weeks of German reunification in 1990, surpassing levels reached during the gilt crisis two years ago.

The repricing came after data Tuesday showed UK wages rose more than expected, prompting traders to rapidly reduce bets on further interest-rate cuts from the Bank of England.

First UK Wage Growth Pickup in a Year Dampens Rate Cut Bets

The BOE has already trailed both the ECB and US Federal Reserve in easing policy this year given the outlook for consumer prices, a stance that has weighed on the gilt market. Attention now turns to Wednesday’s inflation reading, which may cement the pullback in expectations and further darken the outlook.

“Markets are very scared about the wage data and also we have CPI and service inflation data tomorrow,” said Pooja Kumra, senior UK and European rates strategist at Toronto Dominion Bank. “What the BOE is grappling with is very different from other central banks.”

Economists surveyed by Bloomberg see headline inflation in November rising to 2.6% year-on-year from 2.3%. The UK central bank next meets Thursday, when it is expected to keep its key rate steady at 4.75%.

“Monetary Policy Committee hawks will find it difficult to look past this,” Sam Hill, head of market insights at Lloyds Bank Plc wrote in a note following the wage data. 

Limited Scope

The scope for easing from the BOE next year is also looking increasingly limited. Money market traders now see a roughly 40% chance of a third quarter-point decrease in 2025, down from 90% before Tuesday’s report. 

The yield on two-year government bonds, among the most sensitive to monetary policy changes, jumped as much as nine basis points to 4.45%, the highest level since mid-November. The pound bucked a bout of dollar strength to trade 0.1% higher at around $1.27. 

A hot inflation report is likely to hammer home the challenge confronting the BOE, which has to support growth without stoking price pressures. Data last week showed the economy unexpectedly contracted. 

In contrast, the ECB signaled the need for more easing next year when it cut its deposit rate to 3% last week, with officials dropping wording saying policy will remain “sufficiently restrictive” for as long as necessary in their statement.

Data in Europe points to economic weakness, while political upheaval in its two biggest economies — France and Germany — as well as a potential jolt to trade from Donald Trump’s return to the US presidency is hurting investor sentiment.

German bonds were also supported Tuesday by a reduction in the nation’s debt sales plan for next year. The UK, meanwhile, increased its bond-issuance plan in October. 

--With assistance from Alice Atkins.

(Updates pricing throughout.)