Why so quiet at the Bank of England?

It has been a very interesting start to the year in the rates sector of the market. The Fed pivot at the end of last year has been followed by a wave of rhetoric from FOMC members, who are now aligned in agreement that inflation is the key threat and the baseline is now for four rate hikes in 2022. In the market we have seen the bellwether 10-year US Treasury yield move 30bp higher year-to-date (1.82% as of Tuesday morning) and the 2s-10s curve has flattened a further 10bp to 80bp (having been up at 129bp as recently as October). The market has been catching up with the Fed’s increased hawkishness ahead of its policy meeting on January 25-26, and with the Bank of England and European Central Bank meetings both to follow on February 3.

What we are finding particularly intriguing at the moment is the stark contrast between members of the BoE’s Monetary Policy Committee (MPC) and their peers over at the Fed, with the BoE contingent conspicuous in their silence. This appears to be deliberate and coordinated by those in Threadneedle Street; whether this is a new policy of reduced forward guidance from the BoE (as some alluded to last year) or merely a response to criticism of its communication around the November and December meetings, only time will tell, but the market does feel in need of some guidance on what MPC members are thinking here.

However, what is clear is that the sterling rates curve is flatter by far (2s-10s at 35bp) than its US counterpart, and this must be of some concern for the BoE, which would not want to see the Gilt curve continue to flatten and threaten to invert (since market participants look at this as a suggestion of future recession). The Gilt market is of course technically supported at the long end by the UK’s relatively large domestic insurance and pension sectors, but even allowing for this the curve’s current momentum must be on the BoE’s watchlist. 

We hope to hear more from the BoE soon, because while there is a scheduled speech from Catherine Mann this Friday on the economy and monetary policy, this will mark five weeks without what we would consider relevant commentary. It may be that we will have to wait for the February 3 meeting to learn what the collective thinking is from those on the MPC. Given their more hawkish stance at the end of last year, it would be a surprise if they failed to comment further on the threat of inflation and the implementation of tools to tackle this; this would include keeping some degree of gradient to the curve, as allowing it to slip towards inversion would risk a self-fulfilling spiral towards economic slowdown. A base rate hike to 50bp should, according to current guidance, also include the first move to quantitative tightening as coupons and redemptions from the central bank’s bond purchases would no longer be reinvested. This should help maintain that yield curve gradient, but for now we think the curve is almost worryingly flat.

The BoE has already indicated that once it increases base rates to 1%, it will consider selling securities from the balance sheet, again a useful tool for yield curve maintenance, which is why we remain extremely wary of owning duration on the UK yield curve.