(Bloomberg) -- UK government borrowing costs rose toward the highest level in decades relative to Germany’s, spurred on by the latest evidence of inflationary pressures dogging the economy.
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The spread between UK and German 10-year yields widened to as much as 228 basis points. If sustained, that would be the largest gap on a closing basis since the early weeks of German reunification in 1990, surpassing levels reached during the gilt crisis two years ago.
The repricing came after data Tuesday showed UK wages rose more than expected, prompting traders to rapidly reduce bets on further interest-rate cuts from the Bank of England. Money markets now fully price two quarter-point cuts in 2025 and attribute a roughly 40% chance of a third, down from 90% before the report.
The spread closing in on a historic milestone shows the scale of the divergence between the two bond markets. Gilts have lagged peers this year amid persistent price pressures in the UK economy, while German debt has rallied on the outlook for extensive European Central Bank easing.
“Markets are very scared about the wage data,” said Pooja Kumra, senior UK and European rates strategist at Toronto Dominion Bank. “What the BOE is grappling with is very different from other central banks.”
The BOE has already trailed both the ECB and the Federal Reserve in easing policy this year, a stance that has weighed on the gilt market. Attention now turns to Wednesday’s UK inflation reading, which may cement the pullback in expectations and further darken the outlook.
Economists surveyed by Bloomberg see headline inflation in November rising to 2.6% year-on-year from 2.3%. The UK central bank next meets Thursday, when it is expected to keep its key rate steady at 4.75%.
“Monetary Policy Committee hawks will find it difficult to look past this,” Sam Hill, head of market insights at Lloyds Bank Plc wrote in a note following the wage data.
Limited Scope
The scope for easing from the BOE next year is also looking increasingly limited. Money markets imply around 60 basis points of cuts through the end of 2025, compared to over 115 basis points in the euro area.
The yield on two-year government bonds, among the most sensitive to monetary policy changes, jumped as much as nine basis points to 4.45%, the highest since mid-November. The pound bucked a bout of dollar strength to trade 0.2% higher at around $1.27.