Traders have scaled back their bets on the extent of interest rate hikes by the Bank of England this year, influenced by declining oil prices and moderating inflation expectations. Money markets are now pricing in a cumulative 36 basis points of tightening by year-end, the lowest level in over a month. Swaps linked to policy meeting dates indicate this is equivalent to a single 25-basis-point hike, with the probability of a further increase below 50%.
The yield on UK two-year government bonds, which is sensitive to monetary policy shifts, fell as much as 8 basis points to 4.22%, hitting a one-month low. Given the UK's high dependence on imported energy and vulnerability to economic shocks from conflict, traders anticipate that a swift resolution to current tensions could further alleviate inflation pressures.
"Given the significant repricing compared to February levels, UK gilts are certainly poised to outperform. The discussion around shipping volumes through the Strait returning to pre-conflict levels within a month is undoubtedly positive news for the market," said Pooja Kumra, Senior European Rates Strategist at TD Securities.
Brent crude prices have dipped below $95 per barrel for the first time in over a month, having recently reached highs above $115. A draft memorandum of understanding suggests that Iran will resume traffic in the Strait of Hormuz. Combined with potential U.S. sanctions relief, this could return a substantial volume of crude to the oil market.
Just two weeks ago, the market was expecting two rate hikes from the Bank of England this year. In the weeks following attacks involving the U.S. and Israel on Iran, expectations had risen to as many as four hikes. Currently, traders assign roughly a 50% probability to the first rate hike occurring in July.
Last week, Bank of England Governor Andrew Bailey stated that UK inflation expectations have not become unanchored. This followed data showing the annual inflation rate for April had fallen to its lowest level in a year.
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