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Central bankers have warned that inflation appears to be stronger than expected and will cut borrowing costs gradually in 2025, in a move that hit bond markets on both sides of the Atlantic.
A day after Federal Reserve officials dialed back their expectations for a rate cut, the yield on US 10-year Treasuries, the world's benchmark, hit its highest since May at 4.59 percent. The yield has jumped 0.2 percent in the past two days alone as investors are quick to rethink their expectations for Fed policy over the next 12 months.
Long-term US Treasury yields, which move inversely, tend to rise with interest rates and inflation expectations.
UK yields rose to 4.66 percent, the highest in more than a year as Bank of England officials on Thursday warned of a growing risk of “persistent inflation” and kept benchmark rates on hold.
Inflation has begun to re-emerge in the US and UK, while uncertainty about the policies of US president-elect Donald Trump is clouding economic prospects around the world.
Andrew Pease, chief investment officer at Russell Investments, said investors are concerned that there will now be a “slow rate of easing (of monetary policy) until deflation”, citing “final challenges” central banks' strive to bring prices under control.
Concerns that sticky inflation will slow the pace of interest rate cuts have driven a sell-off in US and UK bond markets in recent weeks, combined with worries that tighter monetary policy will make the problem worse.
US stocks fell again on Wednesday after the Fed adjusted interest rates but predicted a smaller rate cut in 2025 than previously estimated. They recovered a bit on Thursday.
Cautious language from the US and UK policy-setters contrasted with the message from the European Central Bank, which last week insisted that the “dark days” of inflation are over, leaving the way open for new rate cuts.
Investors have scaled back their expectations for policy cuts in recent weeks. Traders have priced in a quarter-point-point BoE rate next year, up from four in October. They priced one rate from the Fed next year, with a 50/50 chance of a second, while a double cut was expected last month.
Although they cut rates on a quarterly basis, Fed officials said they only expect to cut rates by 0.5 percent next year, compared to an estimate three months earlier of 1 percent. The central bank's warning is part of Trump's inflationary policies, economists said, pointing to the prospect of tax cuts, higher tariffs and mass deportations.
US inflation readings for September and October came in stronger than expected, adding to discussions of caution. Fed officials on Wednesday raised their inflation forecast for 2025, reflecting those concerns.
The BoE held its key rate at 4.75 percent on Thursday, with most officials signaling higher inflation risks as the bank predicted zero growth in the final quarter of the year.
Trade policy uncertainty has increased “materially”, the BoE said in reference to Trump's tax plans, while emphasizing the impact on UK inflation will not be clear for some time.
While three members of the nine-member Monetary Policy Committee called for an immediate rate cut, most favored keeping the rate unchanged given the increased “risk of inflation”.
“With heightened economic uncertainty, we cannot commit to when or how much we will cut rates next year,” said Andrew Bailey, governor of the BoE, in a statement.