U.K. Break-Even Rate Climbs to 11-Month High on Pound’s Decline

  • Sterling’s tumble since Brexit helped push up import costs
  • First data after EU vote showed acceleration in inflation

U.K. bond investors are gearing up for more inflation as the first effects of Brexit start to ripple through the economy.

The 10-year break-even rate, a gauge of expectations for prices over the next decade, climbed to the highest since September, as the pound’s plunge after Britain voted to leave the European Union pushed up import costs. This is proving to be a bonus for inflation-linked gilts, which have outperformed conventional U.K. bonds this year.

“The post-Brexit impact has definitely been positive for breakevens. We have a weaker currency, lower rates and the Bank of England doing credit easing,” said Mohit Kumar, head of rates strategy at Credit Agricole SA’s corporate and investment-banking unit in London. “It’s like all conditions were well-aligned” for U.K. index-linked bonds to outperform, he said.

The 10-year break-even rate, derived from the yield difference between conventional gilts and those linked to retail-price inflation, climbed to 2.56 percent at 4:28 p.m. London time, the highest since September. The measure jumped 25 basis points, or 0.25 percentage point, since Britain voted to leave the EU.

Annual retail-price inflation, used by the U.K. government to calculate the returns on index-linked gilts, quickened to 1.9 percent last month, the Office for National Statistics said on Aug. 16. Economists forecast the figure will accelerate further in the next year, to 2.8 percent, according to the median estimate in a Bloomberg survey.

The pound was the immediate victim of the “Leave” vote and plunged to its weakest level versus the dollar since 1985 in the weeks after the June 23 referendum. The decline means U.K. inflation will peak at more than 1 percentage point higher a year from now than would otherwise be the case, according to Bloomberg Intelligence economists Dan Hanson and Jamie Murray.

While higher inflation normally may hurt returns of longer-dated conventional bonds, they have been partly insulated by the BOE’s relaunch of its quantitative-easing program in the aftermath of Brexit. Yields of 10- and 30-year gilts hit record lows this month as QE buying resumed.

The central bank’s injection of funds is part of a suite of stimulus announced in August that’s aimed at heading off economic fallout from U.K.’s decision. Index-linked securities are not eligible for the purchases.

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