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Pound and gilts await Bank of England view on inflation

The Bank of England delivers its latest monetary policy decision and inflation report on Thursday with the pound at its strongest level since September.

While not expected to change official borrowing costs, the tenor of the rate-setting committee’s debate and the central bank’s economic projections can move the markets.

Perhaps they can provide more clarity to recent action in currencies and fixed income, where the pound has been rallying but gilts underperforming.

Sterling is trading near $1.30 per dollar, a bounce of 5 per cent so far this year. Yet, the two-year gilt yield is just 0.17 per cent, pushing the spread with equivalent maturity US paper to 116 basis points. That’s near its widest on record as the UK economy is seen lagging its cousin across the pond.

There are a number of ways to explain this apparent pound/gilt dichotomy.

First, sterling’s recent rally mainly reflects a market that was overextended in its bearish pound positioning. These negative bets are being trimmed on hopes Brexit may not be as bad as thought.

Another possibility is that forex and bond investors have different opinions about prospects for the UK economy.

The better explanation is that the Brexit vote, when it whacked the pound, delivered concerns about imported inflation at the same time as worries about economic growth.

“There is clearly already an inflation risk premium priced into the pound,” says Derek Halpenny, currency analysts at MUFG.