(Bloomberg) -- Traders pared bets on interest-rate cuts by the Bank of England next year after another batch of data reaffirmed inflationary pressures in the economy.
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The implied probability of a third quarter-point reduction -- fully priced less than a week ago -- fell to 10% on Wednesday. UK consumer prices rose to an eight-month high in November, drifting further above the BOE's 2% target, while services inflation -- closely watched by BOE rate-setters for signs of lingering pressures -- remained stubbornly high at 5%.
The moves extend a repricing that gathered pace Tuesday, after UK wages rose more than expected and forced the market to reassess the outlook. While the BOE has already trailed peers including the European Central Bank and Federal Reserve, the evidence this week emboldened a market to price in even greater caution from UK policymakers.
"Today's data will only reinforce the MPC's message of patience and gradualism," said Sanjay Raja, Deutsche Bank AG UK economist. "Put bluntly, the MPC is some way away from declaring victory on inflation."
The BOE's stance has supported the pound, but has weighed on gilts and exacerbated their underperformance this year, widening the gulf between yields on government bonds in the UK and Germany to levels last seen in 1990.
The two-year gilt yield, among the most sensitive to monetary policy, is steady at 4.45% while the 10-year yield rose three basis points to 4.55%. The pound erased an earlier modest drop, trading just above $1.27.
UK Bonds Left Reeling as Market Shreds Bets on BOE Rate Cuts
What Bloomberg Strategists Say...
"The big-picture takeaway is that core inflation around 3.5% and services reading at 5% can barely inspire much confidence in the Bank of England to keep cutting interest rates...With the two-year breakeven rate holding above 3.20%, gilts traders will continue to be wary of pricing too many rate cuts."
-- Ven Ram, Cross-Assets Strategist, Dubai
Some investors argue that the latest figures will reinforce fears of so-called "stagflation" -- a high inflation, low growth scenario that presents a significant challenge for policymakers. Data last week showed the economy unexpectedly contracted.
Still, inflation expectations as measured by breakeven rates have fallen this week, indicating traders believe policymakers can keep a handle on price growth.
"Given the weak economy, the Bank will likely be minded to provide a helping hand where possible,"said Jeremy Batstone-Carr, European strategist at Raymond James. "But rate-setters will only do so if inflationary pressures dissipate sufficiently to allow policy loosening without rekindling inflationary fires," he said.