Rates spark: Bank of England likely to join the hiking club

A win for the Democrats helped Brent oil ease below $100, benefiting European government bonds. But we cannot ignore a 4% eurozone inflation reading, showing higher energy costs are already passing through the economy. The same story applies to the UK, where the Bank of England will likely hike rates. But with 24bp already priced in, this won't be a surprise.

Euro rates like Oil sliding below $100, but doesn't change 4% inflation reading

Market sentiment remains positive after Democrats won back both houses of Congress. The feed-through into European government bonds works via a noticeable easing in energy prices, with Brent sliding well below the US$100/bbl mark.

It eases the pressure on the ECB as markets see a greater chance that meaningful second-round effects can be avoided. Front-end inflation swaps have dropped noticeably over the past few sessions, and the money market curve now only expects a little more than 50bp of tightening by summer next year. There is still a contrast to printed inflation, where we saw headline inflation rise to 4% in October with yesterday’s release. We believe tensions will continue to be a source of volatility until time and data give markets more certainty about where we land.

Meanwhile in bond markets, 10y Bund yields slid below 3.3%. The 10y OAT/Bund spread has eased below 150bp, tightening more than 10bp on the day. We had pencilled in some spread tightening towards the end of the year mainly on the expectation that a 2027 budget showing some deficit consolidation will be passed, even if only by decree. But beyond that, the uncertainty ahead of the looming presidential election should leave spreads on wider levels still.

Higher energy prices force a hike from the Bank of England

With energy prices still elevated, we think inflation could reach 4% early next year, which means a hike by the Bank of England (BoE) is warranted. A hike today won’t come as a surprise, with 24bp already priced in, but we are less convinced about the need for more hikes thereafter. Markets take a more hawkish view and price in almost three more hikes after today.

We don’t expect a significant repricing of rates based on today’s meeting, as much will depend on inflation data. Markets have become less correlated with oil and we think each inflation release in the coming months will be anxiously watched for second-round effects. We think inflation dynamics should start improving by mid-2027, warranting the start of a big repricing lower for GBP rates.

Thursday’s events and market views

We start the day with French industrial production in September, for which consensus pencils in -0.3% YoY growth. Other interesting data includes eurozone PPIs for September, which is expected to increase by 10.6% YoY on the back of higher oil prices. From the US, we have challenger job cuts and weekly jobless numbers.

Spain will auction around €6.75bn across 5y, 10y and 14y SPGBs and a 7y SPGBei. France will auction €12bn across 10y, 12y, 17y and 31y OATs.

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