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UK bonds sell off after inflation hits 40-year high

UK government bonds were under pressure on Wednesday morning after inflation figures came in at a 40-year high, increasing traders’ expectations that the Bank of England would respond with more aggressive interest rate rises.

Consumer price index figures for the UK showed a 10.1 per cent year-on-year increase for July, 0.3 per cent ahead of the consensus of economists’ forecasts and 0.6 per cent higher than the June figure.

Fuel and energy costs were the main drivers behind the rampant price rises but core inflation, which strips out these volatile items, also came in above expectations, at 6.2 per cent on an annual basis,

The yield of UK two-year gilts, which are sensitive to interest rate expectations, rose by 0.13 percentage points at the opening to 2.28 per cent. Ten-year gilt yields rose 0.04 percentage points to 2.17 per cent. Bond yields rise when their prices fall.

The move widened the spread between the two-year and 10-year bonds to 0.14 percentage points — the biggest gap since October 2008, according to data from Bloomberg.

An “inverted yield curve” — when short-term government bonds offer higher returns than longer-term government debt — has typically been viewed as an indicator of a looming economic recession. The Bank of England has predicted that the UK will enter a five-quarter recession by the end of the year.

“The extent of the income squeeze now facing households will be difficult to ignore and measures aimed at shielding the most vulnerable are likely,” said Hussain Mehdi, Macro & Investment Strategist at HSBC Asset Management. “However, overall real spending power will remain very constrained and amid a still hawkish Bank of England, recession this year is a base case outcome.”

That overshadowed a quiet session for global equity markets. The FTSE 100, which is weighted towards international energy and commodities companies and has gained 2.05 per cent this year, traded flat, while the pound was largely steady against the dollar and the euro, gaining 0.1 per cent on the greenback to trade at $1.21.

The European regional Stoxx 600 index gained 0.2 percent. In Asia, Japan’s Topix index rose 1.26 per cent, while Hong Kong’s Hang Seng was up 0.9 per cent after falling in the previous session.

The darkening picture in the UK contrasts with the US, where recent CPI data has suggested that inflation is tapering.

The blue-chip S&P 500 and the technology-focused Nasdaq Composite made small gains on Tuesday, both closing up 0.2 per cent, after strong results for consumer bellwether Walmart and DIY retail chain Home Depot. Futures contracts tracking the S&P 500 and Nasdaq 100 were down slightly on Wednesday morning.

Later on Wednesday, the release of minutes from the Federal Open Market Committee meeting in July will give market watchers further clues about the Federal Reserve’s plans to tackle inflation.

Concerns over global growth persist. Brent crude gained 0.9 percent on Wednesday but it continued its downward trend on Tuesday, falling 2.9 percent to settle at $92.34 a barrel, while US marker West Texas Intermediate dropped 3.2 percent to $86.53 a barrel.

Oil prices, a barometer of global economic output, have reached lows last seen in February and late January, before Russia invaded Ukraine.

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