(Bloomberg) -- UK government borrowing costs rose to the highest level in decades relative to Germany’s, as traders grew increasingly skeptical over how much more easing the Bank of England will manage to deliver next year.
The spread between UK and German 10-year bond yields widened to 229 basis points, the highest on a closing basis since the early weeks of German reunification in 1990, and surpassing levels reached during the gilt crisis two years ago.
The repricing came after data Tuesday showed UK wages rose more than expected, prompting traders to rapidly reduce bets on further interest-rate cuts from the BOE. Money markets are fully pricing two quarter-point cuts in 2025 and attribute a roughly 20% chance of a third, down from 90% before the report.
The historic milestone shows the scale of the divergence between the two bond markets. Gilts have lagged peers this year amid persistent price pressures in the UK, while German debt has rallied on the outlook for extensive European Central Bank easing as the euro area’s biggest economy falters.
“Markets are very scared about the wage data,” said Pooja Kumra, senior UK and European rates strategist at Toronto Dominion Bank. “What the BOE is grappling with is very different from other central banks.”
Attention now turns to Wednesday’s UK inflation reading, which may cement the pullback in expectations and further darken the outlook for bondholders. Economists surveyed by Bloomberg see headline inflation in November rising to 2.6% year-on-year from 2.3%.
The UK central bank next meets Thursday, when it is expected to keep its key rate steady at 4.75%. Money markets then imply around 55 basis points of cuts through the end of 2025, compared to nearly 120 basis points in the euro area.
“Monetary Policy Committee hawks will find it difficult to look past this,” Sam Hill, head of market insights at Lloyds Bank Plc wrote in a note following the wage data.
The yield on two-year government bonds, among the most sensitive to monetary policy changes, jumped as much as 10 basis points to 4.46%, the highest since mid-November. The pound bucked a bout of dollar strength to trade 0.2% higher at around $1.27.
Diverging Outlook
A hot inflation report is likely to hammer home the challenge confronting the BOE, which has to support growth without stoking price pressures. Data last week showed the economy unexpectedly contracted.
In contrast, the ECB signaled the need for more easing next year when it cut its deposit rate to 3% last week, with officials dropping wording saying policy will remain “sufficiently restrictive” for as long as necessary in their statement.
Data in Europe points to economic weakness, while political upheaval in its two biggest economies — France and Germany — as well as a potential jolt to trade from Donald Trump’s return to the US presidency is hurting investor sentiment.
German bonds were also supported Tuesday by a reduction in the nation’s debt sales plan for next year. The UK, meanwhile, increased its bond-issuance plan in October.
“Faster wage growth risk fuelling services inflation and raises the bar for the BOE to deliver additional rate cuts,” said Elias Haddad, senior markets strategist at Brown Brothers Harriman & Co.
--With assistance from Alice Atkins and Naomi Tajitsu.
(Updates pricing throughout.)
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