Column-Sterling caught between rate spike and gilt rupture: Mike Dolan By Reuters

By Mike Dolan

LONDON (Reuters) – Britain’s interest rate horizon skyrocketed this week on another alarming inflation reading that some fear entrenches the economy as outlier among Western peers – and yet the pound didn’t know whether to laugh or cry.

Unlike its dire reaction to UK bond market ructions surrounding last September’s government budget farce, when it lunged to near record lows of the pandemic, sterling has held up well so far against a similarly seismic shift in the government bond, or gilt, market this week.

While it lost ground to a resurgent dollar – which was infused by a mix of debt ceiling anxiety, hawkish Federal Reserve soundings and an AI-driven dash for U.S. tech stocks – sterling flatlined on the more telling euro cross rate and its overall index held the line too.

On the flipside, the fact that it gained nothing on the euro despite a 30 basis point increase in the premium on 10-year gilt yields over German benchmarks was equally telling and made many wonder whether a different shade of risk premium is re-emerging.

Some feel that’s less the unkindly-dubbed ‘moron premium’ related to the political policy missteps of eight months ago than a longer-term inflation insurance fee at least partly related to the structural hit from Brexit.

“It is a very ugly look for a currency when a huge leap in more hawkish central bank anticipation fails to support the currency,” opined Saxo’s currency strategist John Hardy, referring to the near half-point leap in money markets’ pricing of peak Bank of England interest rates this week to near 5.5%.

“The UK is dogged by supply-side shortages, particularly in labour, that are the chief Brexit ‘gift’,” he said, adding a resultant stagflation risk for the economy continues to leave fiscal and monetary policy in a bind.

To be sure, the April inflation data hit the UK debt market like a thunderbolt.

While the headline consumer price inflation rate dropped to 8.7% from 10.1% in March, as energy prices ebbed, that was still far higher than forecast and core inflation rates hit their highest in 31 years at just under 7%.

What’s more, relief about a return to single-digit headline inflation was challenged by other cuts of the number.

The National Institute of Economic and Social Research (NIESR) calculated that its ‘trimmed mean’ inflation measure, which excludes 5% of…