HSBC said UK inflation is still running above the Bank of England’s target, even after CPI eased to 2.8% in May, and it flagged ongoing wage pressures alongside weak consumer confidence. The BoE kept its policy rate unchanged at 3.75% in June, while the bank expects growth to remain modest given mixed economic signals.
With energy prices stabilising after the US-Iran interim peace agreement, HSBC characterised inflation risks as more balanced and adjusted its outlook to assume no further rate hikes in 2026, while still expecting the BoE to keep rates steady this year. Inflation is forecast to peak at 3.25% in Q4 as second-round effects from the Middle East conflict are contained; positioning remains neutral on UK gilts and UK equities, overweight GBP investment grade credit with a preference for 5–7-year duration, and GBP high yield has been moved to neutral.
Monetary Policy Expectations and Market Volatility
Given the recent stabilization in energy markets, we believe the Bank of England’s rate hike cycle has concluded for 2026. The decision to hold rates at 3.75% in June reinforces this view of a prolonged pause. This shift means traders should adjust away from expecting further monetary tightening.
We anticipate a significant drop in short-term interest rate volatility in the coming weeks. Implied volatility on three-month SONIA futures has already compressed following the Bank’s recent meeting, a pattern historically seen at the end of hiking cycles. Therefore, strategies that profit from range-bound rates, such as selling straddles on SONIA contracts, now appear more attractive.
Equity and Credit Market Positioning
Our neutral outlook for UK equities suggests the FTSE 100 will likely trade within a defined range. With the VFTSE index of implied volatility recently falling to a 12-month low of 14.5, option premiums are becoming less expensive. This environment favors strategies like covered calls on existing holdings to generate income rather than betting on large directional moves.
The improved risk sentiment is most evident in the credit markets, supporting our positive stance. The Markit iTraxx Europe Crossover index, a key gauge of high-yield risk, has already tightened by 25 basis points since mid-June. We see opportunities in selling credit protection via credit default swaps (CDS) on investment-grade corporate indices, capturing premium as default risks recede.
However, we remain watchful of persistent domestic price pressures. While headline CPI eased to 2.8% in May, recent ONS data showed core inflation remains sticky at 3.5%, well above the 2% target. Any upside surprise in wage growth or services inflation could quickly challenge the market’s view of a firm pause, creating a risk for short-volatility positions.
