The Bank of England’s decision maker panel (DMP) reported that businesses’ year-ahead expected own-price inflation averaged 4.1% in the three months to June, edging up by 0.1 percentage points from the three months to May.
The DMP also found that firms’ year-ahead expected wage growth rose by 0.1 percentage points to 3.5% in the three months to June, compared with 3.4% in May.
Inflation Expectations And Monetary Policy Implications
The latest business survey data shows expectations for future price and wage increases are ticking up again. This suggests inflationary pressures in the UK are proving more persistent than previously hoped. We see this as a clear signal that the fight against inflation is not over.
This stickiness will likely force the Bank of England to maintain a more cautious stance in the coming weeks. The market has been pricing in a series of rate cuts, but this data makes an imminent move less probable. Recent official data already showed core CPI inflation holding at 3.1%, still significantly above the Bank’s 2% target.
Given this, we believe interest rate markets are mispricing the path of monetary policy. We should consider positioning for fewer rate cuts this year than the two currently implied by SONIA futures. This involves selling near-term interest rate futures to reflect a higher-for-longer rate environment.
Market Opportunities And Volatility Outlook
This policy divergence should also create opportunities in the currency markets. With the Bank of England staying hawkish while other central banks like the ECB signal a clearer path to easing, we see strength in the pound. We should look at buying GBP/USD call options, targeting a move above the recent 1.2900 resistance level.
For equities, sustained high interest rates present a headwind for corporate profitability and valuations. Historically, periods of unexpectedly stubborn inflation have led to market downturns as future earnings are discounted more heavily. Therefore, we are considering buying put options on the FTSE 100 as a hedge against a potential market correction.
The increased uncertainty surrounding the Bank of England’s next move will likely push up market volatility. Implied volatility on short-term UK interest rate options, known as swaptions, has already climbed by 5% in the last week. We see an opportunity in buying straddles on SONIA futures ahead of the next policy meeting in August.
