U.K. Linkers Beat Gilts as Brexit Seen Spurring Faster Inflation

  • Returns almost double those on nominal bonds since EU vote
  • Weaker pound spurs index-linked debt even as it pares its loss

The Brexit vote has got bond investors gearing up for faster inflation.

While that would be bad for consumers, it’s a bonus for index-linked gilts, which have posted almost double the return on conventional U.K. government securities since the nation voted to leave the European Union on June 23. The weaker pound in the wake of the referendum is likely to make imported goods more expensive, which has helped push the long-term inflation outlook to the highest since January by one debt-market measure.

“The short end of the curve seems to have come to the conclusion that Brexit will be inflationary, mainly because of the weaker pound,” said Alan Clarke, an economist at Scotiabank in London. The market is “aiming higher” on inflation, betting on an “abrupt upward shift” in price increases, which is helping index-linked bonds, he said.

Linkers, as they’re known, have returned 8.2 percent since June 23, compared with a 4.8 percent gain in nominal debt, according to Bank of America Merrill Lynch indexes.

While sterling has rallied for the past three days, it’s still almost 9 percent weaker versus the dollar since the nation went to the polls. The pound rose 0.2 percent to $1.3453 as of 11:05 a.m. in London, after posting its biggest-ever decline the day after the referendum. It sank further on Monday, touching a three-decade low of $1.3121.

Inflation Outlook

The 10-year break-even rate -- a gauge of the retail-price inflation outlook derived from bonds -- climbed to 2.44 percent, the highest since Jan. 28 and up 13 basis points, or 0.13 percentage point, since the end of last week. Annual consumer-price inflation is running at just 0.3 percent, compared with the 2 percent targeted by the Bank of England.

BOE Governor Mark Carney is due to speak in London this afternoon, and investors will be watching for clues as to how policy makers will deal with the fallout from Brexit. He said on Friday that officials would take any steps necessary to secure stability.

Gilts across the board have been buoyed by speculation that a Brexit-driven economic downturn will prompt the central bank to consider interest-rate cuts. But bonds that protect holders against inflation are benefiting more, since faster price gains would eat into the fixed-returns offered by conventional debt.

The chance of a rate reduction by the central bank’s August meeting have climbed above 50 percent, according to futures data compiled by Bloomberg. That’s up from just 15 percent before the result of the U.K.’s historic vote was known.

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