Halister News

(Bloomberg) -- The bounce in U.K. 5Y real rates may have more room to run because the currency pass-through to inflation typically isn’t sustained in the longer term, Bloomberg strategist Tanvir Sandhu writes.

• FX weakness should hence have less impact on 5Y compared with front-end; even the GBP TWI collapse of 25% in 2008 (vs 14% this year) boosted inflation above target only during 2009–13
• U.K. 5Y inflation-indexed bond yield has now risen to -222bp from a 3 1/2-year low of -258bp on Oct. 11; in April 2013, the rate hit an all-time closing low of -263bp
• GBP RPI 5s10s spread has narrowed to almost zero, which is rare, indicating 5y has overshot vs longer end; see chart here
• GBP Sonia 5y1y at 1.28% is inconsistent with the RPI swap curve, which is flat across the 3-10Y sector at about 3.5%
  • Real policy rates should move higher as the richness in inflation forwards may fade as they seem to have overpriced the FX impact
• See live chart here of U.K. 5Y real rate vs GBP TWI and the pricing of lagged pass-through to come; real rates may be supported given the lagged currency boost to inflation is to pass and with BOE staying averse to negative rates
• Issuance risks are rising for the long end of nominal curve given likely weaker growth forecasts due to Brexit; however, a deterioration in growth may eventually outweigh
• BOE official Kristin Forbes’ 2015 paper had concluded that exchange-rate pass-through is relatively large in response to domestic monetary policy shocks, but smaller in response to domestic demand shocks
• NOTE: Front-end GBP inflation markets underpinned by import tariff risks and Brexit-induced supply-side weakness; will require a rally in sterling, collapse in oil prices and/or rise in inflation bond supply to adjust significantly lower again; see more here

• 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.