Bond yields surge
The rout in government bond markets gathered pace yesterday as a hawkish ECB rate hike, a further spike in oil prices (to over $105 p/b in the case of Brent) and solid producer output price inflation data in the US all contributed to a surge in yields. The move higher in yields was led by the short end of curves on the back of a pronounced firming of central bank rate hike expectations. Remarkably, the market priced in an additional 20-25bps of hikes by both the Fed and Bank of England by the middle of next year, while it sees the ECB raising rates by another 75bps over the same period (on top of the 50bps it has done to date). Amidst all of this, there wasn’t a whole lot of change in the main currency pairs. The euro and sterling are both marginally weaker against the dollar relative to yesterday morning’s levels, trading at around $1.1610 and $1.3520 respectively, leaving EURGBP still hovering just below £0.86. Attention now turns to today’s CPI inflation data for August in the US, which could have an important bearing on whether the Fed raises interest rates next week – ahead of the data, the market is pricing in a circa 70% chance of a quarter-point hike.
The short-end of government bond markets led a sharp move higher in yields. US, UK and German 2-year yields ended 16-18bps higher on the day, while US and UK 10-year yields rose by around 10-12bps and equivalent German yields by just over 5bps. The pronounced rise in short-end yields reflected a marked firming of central bank rate hike expectations. The market now sees the Fed and BoE raising rates by circa 75bps and 100bps by mid-2027, while the ECB is expected to hike by another 75bps over the same period. Meanwhile, higher bond yields again weighed on equity markets with both US and European stocks shedding just over half a percent on the day.
The ECB raised the deposit rate by 25bps, as widely expected. It noted that “the conflict in the Middle East continues to generate inflation pressures” and said inflation is now “set to remain well above target for an extended period”. It nudged up its forecasts for both inflation and GDP growth, but said the “outlook remains highly uncertain, with risks to the upside for inflation and to the downside for economic growth”.
The UK economy expanded by a greater than expected 0.4% month-on-month in July, according to GDP data published a short while ago, with output increasing across services, industry. and construction. Over the three months to July, GDP rose by 0.4% versus the three months to April, and was up 1.3% on May-July 2025.
For the day ahead, as mentioned, the key release is the August CPI inflation report in the US. The consensus expects headline inflation to have remained unchanged at 3.4% last month, while core inflation is seen nudging down to 2.4% from 2.5% in July. Other US data due include the University of Michigan consumer confidence index for September.