Investors pile into British debt as hopes of US interest rate cut fade

INVESTORS are racing to buy British debt as traders ramp up bets that the Bank of England will start cutting interest rates before the US Federal Reserve.

Official data showed US inflation rose by more than expected in March in a blow to US rate cut hopes.

Stock markets fell and global borrowing costs jumped following the figures as traders reappraised their rate cut predictions.

Traders now believe the Fed will only cut interest rates twice instead of three times this year, with the first reduction pushed back from September to November. The figures were released just hours after the UK sold £5bn in short-term gilts, with demand outstripping supply almost four times over.

This is the strongest demand for UK debt since April 2020, when recession fears led to investors ploughing billions of pounds into gilts during the first pandemic lockdown.

Imogen Bachra, a rates strategist at Natwest, said the recent strong demand for short-term debt was driven by expectation that the UK will cut rates before the Fed. “Investors that think that the Bank could cut before the Fed and more than the market is currently pricing,” she said.

Traders now believe the Bank of England will begin cutting rates from 5.25pc in August, three months before the Fed and a month after the European Central Bank. Speculation is growing that the US will have to keep interest rates higher for longer after figures showed consumer prices rose by 3.5pc in March compared with a year earlier.

Inflation accelerated from 3.2pc the previous month and was greater than the 3.4pc predicted by analysts.

The data add to evidence that the US economy has cooled less than policymakers would like in the face of 23-year high borrowing costs.

The monthly inflation measure remained flat at 0.4pc in March, defying expectations of a slight easing to 0.3pc. Former US Treasury secretary Larry Summers said the surprise jump in the headline inflation rate raised the prospect of another increase in borrowing costs by America’s central bank. He told Bloomberg: “You have to take seriously the possibility that the next rate move will be upwards rather than down.”

Markets plunged in response to the inflation figures, with the benchmark S&P 500 closing down 0.95pc and the tech-heavy Nasdaq falling 0.84pc. In the UK, the FTSE 100 pared most of its earlier gains, ending up 0.3pc at 7,961.

Megum Muhic, a rates strategist at RBC Capital Markets, said investors no longer believed the UK had an inflation problem. While the rate of price rises in the UK is only marginally different to the US – at 3.4pc – inflation here has been falling faster than expected and is forecast to fall below the Bank’s 2pc target within months, reflecting a big drop in energy bills.

Mr Muhic said: “The UK market had for a long time been trading with a narrative where people thought that the UK had this idiosyncratic, sticky inflation problem. It was seen as a bit of an outlier.

“Now, it’s starting to see inflation coming in below expectations, whereas in places like the US, inflation has come in above expectations.”

Some observers believe the Bank is unlikely to cut before the Fed, given it will leave Britain exposed to potential capital outflows if a rates gulf emerges with other economies.

However, strategists and fund managers at Jupiter Asset Management, Pictet Asset Management and Candriam have all said markets are underpricing the chances of the Bank of England cutting sooner and deeper than its major counterparts.