Here’s How Investors Responded To The Highest UK Inflation In 40 Years

Here’s How Investors Responded To The Highest UK Inflation In 40 Years
Carl Hazeley

over 1 year ago2 mins

Fresh data out on Wednesday showed UK consumer prices in July were 10.1% higher than the same time last year. That’s the biggest inflation reading in 40 years. Here’s how investors responded…

In currency markets, the British pound initially rose in value versus the dollar. Inflation, which is forecasted to exceed 13% in October, could push the Bank of England (BoE) to raise the country’s interest rates higher, faster. All else being equal, money saved in the UK will earn more interest, and that would encourage investors to buy into the British currency to take advantage. On the flip side, however, it suggests a long recession’s on the UK’s horizon, because while those rate hikes may bring down the inflation by squeezing spending, they’re likely to also strangle the economy. Investors, naturally, don’t like the thought of that so much, which might explain why the pound’s rise was quickly undone.

Prices of short-term UK government bonds fell and there are probably two major reasons why. One: higher forthcoming interest rates mean new bonds (whose rates are partly benchmarked to central bank rates) will offer higher interest rates than existing bonds, making those already out there a little less attractive to investors. And two: higher and faster BoE rate hikes should crimp economic activity, upping the chances of a long and deep recession. So with the near-term looking bleak, investors seem inclined to ditch short-term bonds since they’d come due during a rougher economic patch, and instead buy up long-term bonds, which would come due when the economy’s likely to be back on more solid ground.

Since bond yields move in opposite directions to their prices, investors’ favoring long-term over short-term bonds causes an “inversion” in their yields – with short-term bonds having a higher yield than long-term ones – and that rate gap became even bigger on Wednesday. Inversions are historically a sure sign a recession is coming and can, in a sense, therefore become a self-fulfilling prophecy, as consumers and businesses cut back their spending...



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