Here's What May Happen If Markets Catch Up to Analysts on BOE Rates

  • Nine months' difference between market, economists' rate views
  • UniCredit recommends positioning for `multi-week' pound gains

A reflection of the Bank of England (BOE) in London.

Photographer: Simon Dawson/Bloomberg

The gap between where markets price a Bank of England interest-rate increase and when economists say it will happen has gotten to the point where strategists predict U.K. assets are on the brink of a surge in volatility.

Forward contracts based on the sterling overnight index average, or Sonia, are now more than nine months behind a survey of economists in their expectations of when the BOE will move. For UniCredit SpA, that paves the way for a sudden jump in the pound if market indicators suddenly start to catch up, while UBS AG warns short-dated government bonds may sell off.

“Markets have been as far removed from economists and the central bank as they’ve been at any time for the past few years,” said John Wraith, head of U.K. rates strategy at UBS in London. “That leaves you with a situation where the front end” of the bond market is “vulnerable” to a selloff, he said.

Forward Contracts - Sonia

The gap between when markets and economists anticipate a rate hike has increased since the Federal Reserve held off raising its own benchmark this month, and back in August -- before China roiled markets by devaluing the yuan -- was as little as five months. Some BOE Monetary Policy Committee members have also signaled a move early next year.

The problem, UBS’s Wraith says, is that traders don’t believe them and are focused more on the Fed.

Following Fed

The timing of the U.S.’s first rate increase since the global financial crisis is important to U.K. investors because the BOE is widely expected to follow on the heels of its counterpart across the Atlantic.

More than three-fourths of economists in Bloomberg’s survey see the BOE lifting its 0.5 percent main rate in the first quarter of 2016. Sonia, on the other hand, has pushed back the timing of the first quarter-point increase at least until November next year.

BOE Governor Mark Carney will speak later on Tuesday and is due to discuss the latest policy decision on Oct. 8.

While there’s nothing new about a difference in opinion between central banks and economists on the one hand and markets on the other, the growing chasm shows how much U.K. assets might react on a sudden consensus.

Sterling’s 2.3 percent decline against the dollar last week was “unjustified” by the rate differentials between the U.K. and the U.S., and “an attractive opportunity to position for sterling strength on a multi-week basis,” UniCredit strategists led by Vasileios Gkionakis, the London-based head of global foreign-exchange strategy, wrote in a Sept. 28 note.

“The BOE will follow the Fed much more swiftly than the market currently anticipates, and this should provide further tailwinds for the pound,” they wrote.

UniCredit recommended buying sterling on dips, targeting $1.5750, compared with the pound’s rate of $1.5142 as of 4:06 p.m. in London.

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