HALISTER1: BOE’s On-the-Fence Outlook to Keep Front-End Rates Gamma on Edge

BOE’s On-the-Fence Outlook to Keep Front-End Rates Gamma on Edge

(Bloomberg) -- GBP front-end may now require a more tactical approach given BOE may not be comfortable with the rally in reaction to its latest statement. This may bode well for fading any steepening of GBP gamma curve and keep volatility rich relative to EUR, where ECB has successfully extended lower volatility for longer.
  • The scale of the GBP rates rally, lead by 5-year real rates (-11bps), raises risk of MPC hawks pushing back against potential dovish reaction over the next few weeks
  • GBP 2s10s 6- month implied vol curve at 1.13bp/day (see chart here); GBP-EUR 6m2y implied volatility spread is at 1.3bp/day (see chart here)
  • BOE will not want to lose the rates curve where it could further weigh on sterling and add to the real-income squeeze while the main focus for the ECB now is keeping control of the short-end of the curve, keeping short gamma strategies in schatz alive
  • BOE expects potential growth at only 1.5%, which implies a lower terminal rate but also a lower bar for the next rate hike
  • While the central bank omitted the language from previous statements saying that more hikes could be needed than the market expects, the inflation forecast profile still remains hawkish
  • BOE still projects persistent overshoot of CPI inflation above MPC’s tolerance, expecting 2.21% 2-years and 2.15% at 3- years, only marginally reducing forecasts compared to August and implicitly suggesting more tightening is needed than currently priced
  • GBP 3-year forward 1-year Sonia rate -- a proxy for the BOE’s terminal rate -- is hovering around 1%, which remains too low relative to the inflation projections, leaving either inflation projections too high or terminal rates too low
  • NOTE Tanvir Sandhu is an interest-rate and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice
To contact the reporter on this story: Tanvir Sandhu in London at tsandhu17@bloomberg.net To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net Anil Varma

Alert: HALISTER1
Source: BFW (Bloomberg First Word)

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