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By James Hirai

(Bloomberg) –

British traders are starting to backtrack after betting that the Bank of England will raise rates this year.

As bets on increases over the next year have been raised to over 100 basis points, concerns about this pace of tightening are now surfacing in various corners of the market. Book traders haven’t pushed the currency higher and interest rate swaps signal that any tightening may soon be followed by easing.

All of these are signs of fears that the rate hikes are a mistake that squeezes consumers, amid a heady mix of threats to the Brexit deal, soaring Covid cases and prices. sky-high energy. This backdrop sets the stage for the November rate decision – a move chief economist Huw Pill called “finely balanced.”

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“Markets believe the BOE will not be able to raise rates much, signaling that future hikes will slow inflation as well as the economy,” said Bob Stoutjesdik, fund manager at Robeco Institutional Asset Management. “You can label this as a pricing policy error. “

Here’s a look at some of the ways investors question the height of rates:

Book confuses

The pound has broken its link with bond yields, holding below $ 1.40 for a fourth month even as two-year rates hit their highest level since May 2019. Higher rates supported the currency in the past, but investors are now wondering what it all means. for the pound.

The managers of Jupiter Asset Management and Aberdeen Asset Management have turned neutral on the pound sterling in recent days, following similar moves by Amundi SA and William Blair Investment Management. Meanwhile, strategists polled by Bloomberg lowered their year-end median forecast to $ 1.37, from $ 1.43 four months ago.

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Read more: Pound stuck in limbo as debate rages on timing of UK rate hike

The BOE will likely defy investor expectations of a sudden interest rate hike next month, as it rarely changes its policy so dramatically, according to three former senior officials.

Any indication of less immediate tightening and a more gradual rate hike path would strengthen the pound, according to Peter Chatwell, head of multi-asset strategy at Mizuho International Plc.

“This would be an effective use of forward guidance, as any credible central bank in developed markets would use,” Chatwell wrote.

Up, then down

The market proxy for the BOE’s future level of interest rates – the sterling overnight index swap curve – also casts doubt on the longevity of any policy tightening. This signals that the policy rate will peak at around 1.15% in 18 months, falling back to around 1% by the end of 2024. This has resulted in an inverted curve, which is interpreted by some as a sign of economic collapse. imminent. .

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U-turn costs

Similar doubts arise in the short-term pound sterling contracts which are linked to three-month funding costs. The spread between maturities in two to three years – an indicator of where interest rates may go – has reversed the most since the global financial crisis of 2008. This is another indication that traders are ‘expect any tightening to be followed quickly by further easing.

Borrowing costs

Forward swaps – which are used by pension funds, insurers and companies to manage future liabilities – offer another signal from the markets for a possible policy reversal. The two-year rate is the most above its three-year equivalent since 2008. At the time, markets and policymakers were struggling with the fallout from the global financial crisis, causing swift and sometimes inexplicable moves.

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This week / next week

The ECB’s policy outcome on Thursday dominates the agenda with President Christine Lagarde expected to comment on bets on a rate hike of at least 10 basis points by the end of next year An offer € 23 billion European government bond is expected from Germany, Italy and the Netherlands according to Citigroup Inc., while the EU will sell a 7-year bond up to 2 , 5 billion euros; UK to sell up to £ 2.75bn of five-year banknotes On the data front, highlights are Eurozone and Germany inflation figures for October and figures for third quarter growth; Germany also publishes the October Ifo survey; British Chancellor Rishi Sunak unveils budget on Wednesday

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