Falling UK Gilt yields look set to collide with rising inflation expectations

Today sees the latest data on UK inflation but let us first look at things from a different perspective. On Friday the Bank of England released the results of its survey on inflation expectations which had some intriguing results.

Question 1: Asked to give the current rate of inflation, respondents gave a median answer of 2.2%, compared to 2.0% in February.

Question 2a: Median expectations of the rate of inflation over the coming year were 2.0%, compared with 1.8% in February.

As you can see there is at first some brief satisfaction for the Bank of England as inflation is considered to be pretty much on target. However there is a problem with that because it means that the official target of CPI or Consumer Price Index is a long way away from where people think inflation actually is. For newer readers this has been one of my arguments for the Retail Price Index or RPI which has been above 1% mostly as opposed to being around 0%. It has fitted inflation expectations much more accurately than CPI for some years now. Officially the “experts” know better than us plebs although even official sources have to accept that the “experts” in this area have built up a track record of being wrong. For example the disastrous decision to have a main inflation measure which leaves out owner-occupied housing costs, and then a decade later to use rents as a proxy shortly followed by abandoning the discredited rental series.

A crunch coming?

There appear to be two trains on the same line in financial markets right now. Let me illustrate first by returning to the inflation expectations survey.

Asked about expectations of inflation in the longer term, say in five years’ time, respondents gave a median answer of 3.4%, compared to 2.9% in February.

As you can see higher inflation is expected and in particular a rising trend. As to the exact numbers they are of course not known but we do have higher inflation expectations which sit oddly with this morning’s market news.

UK 10-year yields fall to all time lows of 1.18%

As you can see the yield is already below what ordinary people think inflation is and looks set to fall even further below it. There is a question about the efficient operation of markets here because real yields look likely to be very negative. In other words the flight to yield driven by the Bank of Japan and the ECB is bending and twisting markets and may yet break them.

Oh and such moves are usually described as a flight to safety by the media but of course a week or so ahead of the Brexit referendum? Anyway those who claimed this would lead to higher Gilt yields and challenged my view on Twitter must be busy as they have vanished.

Even as I am typing this the drum beat is going on relentlessly and a bass line has joined it.


There are two main issues here. Firstly it also reminded me that I have been following the Gilt market for 30 years now ( Eeek…) and for perspective I recall the long Gilt yielding over 15%. Secondly this represents an utter failure for the Forward Guidance of Bank of England Governor Mark Carney as it was the summer of 2014 when he hinted at interest-rate rises.

It could happen sooner than markets currently expect.

Two years later we see he completely misled remortgagors and businesses as not only has Bank Rate not changed but market interest-rates as I have explained above have fallen substantially. Maybe one day our supine media will grill him about it.

Also should the UK ever wish to renew some infrastructure it could do so as cheaply as it ever has or at least for as long as we have kept records.

House Prices

The problems that the UK official statisticians have with the UK housing sector are highlighted by the fact we have a new improved house price series starting today. Also we see an obvious issue if I show you the numbers.

UK average house prices have increased by 8.2% in the year to April 2016 (down from 8.5% in the year to March 2016), continuing the strong growth seen since the end of 2013……The average UK house price was £209,000 in April 2016. This is £16,000 higher than in April 2015, and £1,300 higher than last month.

Now let us compare that to the official consumer inflation numbers.

The Consumer Prices Index (CPI) rose by 0.3% in the year to May 2016, unchanged from April.

Even when they try to put some measure of housing inflation into the numbers via using rents you can see that the numbers look like they are from a different universe to the one we actually live in.

In May 2016, the 12-month rate (the rate at which prices increased between May 2015 and May 2016) for CPIH stood at 0.7%, up from 0.6% in April 2016…..The OOH component annual rate is 2.3%, up from 2.2% last month.

So they registered a small uptick but are way behind house prices unless 2.3% is the new 8.2%, whereas if you put them in then inflation would be more like 1.5% and a lot of the paranoia would disappear. This is because we would then be much closer to the inflation target of 2% per annum.

It is also true that if you look you can see signs of an inflationary pick-up. For example here.

The CPI all services index annual rate is 2.6%, up from 2.4% last month.

When you look wider and consider that they represent around 80% of our economy it is a warning of sorts. When goods prices end the current disinflationary phase then our whole trajectory will change.

Actually if you look there are signs of inflation in the rental sector as with a hat tip to @youngvulgarian I note you get this for £800 per month in Nunhead South East London which is not far from where I grew up.

Fabulous studio flat, presented to a high standard, offering a splendid and airy studio room, along with a large en suite shower room and long balcony. No kitchen as such, just a hot plate small fridge and a microwave.

So “no kitchen as such” goes into my financial lexicon for these times as I note that couples would have to pay £1000 per month.


There is much to consider as we note that inflation expectations and bond yields are two trains running in opposite directions on the same track. The exact path of inflation is unknown as we do not know what oil prices will do but we do know they will have to continue to fall for inflation to stay where it is. Also as someone who questions official inflation measures I would point out that even the UK 30 year Gilt is now offering no real yield at all on current expectations and looks set to go negative. Something will have to break here and on that subject let us remind ourselves of the problems caused for all long-term business models such as pensions and annuities by all of this. It is another nail in the coffin for UK final salary or defined benefit pension schemes which remember are valued via the yields which are falling as the deficits go on an apparent journey to infinity and beyond. That should be raised at the BHS parliamentary enquiry but of course there is no opportunity for grandstanding provided and it also requires an understanding of the issues.

Meanwhile we have been expecting this.

German 10y Bund powering lower -0.03 now ( @creditmacro )




20 thoughts on “Falling UK Gilt yields look set to collide with rising inflation expectations

  1. Hi Shaun,
    Excellent blog as usual. I firmly predict, however, that there will be no “collision” between gilt yields and inflation, as:
    1. That would suggest that markets are free to operate, whereas I happen to believe that the whole thing is utterly rigged by QE/requirements for pension funds to hold certain asset classes etc;
    2. The entire political establishment (in which I include the BofE) is devoted to:
    a) Can-kicking down the road;
    b) Fiddling the figures. If inflation rises, they will simply rebase it to some new mythical series.
    I have a feeling that the scale of the problems and the mess being created by extreme measures combine to make rational or classical economic analysis almost impossible or pointless.

    • yes more or less its impossible and pointless when theres the wealth of the Banks and the top 0.1% to protect .

      even then we had more wealthy people in the past , now we have fewer, more stella wealthy and soon I predict we will have , one man (unlikely to be woman) who owns half of everything or more

      a new King , king of the world …..


      PS: Oil prices are set to rise as production is cut and demand is still rising ……

  2. Hello Shaun,

    My I suggest on James’s line that you put forward to the BoE the Unicorn series of inflation measurement ……….

    or perhaps

    “When I use the word inflation ,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’

    ’The question is,’ said Alice, ‘whether you can make inflation mean so many different things.’

    ’The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all.”

    Eventually the Pensions companies will either need QE3 or 4 or go bust

    if the Banks are liable to go down if the Pensions companies go down , its a fore gone conclusion its QE , not bust

    Also I think that the public are going to go ape when they find out they are forced into pension schemes that will return 97pence on every pound , if not less (!!)

    ” Workplace pensions, we’re in it ( $h!t ) together …..”


    PS: I thought HMG was refunding to the lower rates ? perhaps they’re scared if they do more they’ll spook the horses ….

    • Hi Forbin

      I was watching a repeated episode of Yes Prime Minister last night ( the one on education from 1988) when the issue of official misrepresentation of data came up.Apparently you just rebase the numbers…….So it has been going on for at least 3 decades.

      Or perhaps better still

      Bernard Woolley: [Discussing the Prime Minister’s dilemma about education] He can’t ignore facts.
      Sir Humphrey Appleby: If he can’t ignore facts, he’s got no business being a politician.

  3. Hi Shaun

    The inflationary trajectory is certainly upwards as you suggest and there must be at least a reasonable chance that it will go above the 2% threshold in two years time, considering the persistence of service sector inflation. So why aren’t the BOE signalling IR changes upwards?

    Because they can’t. I think we will get a repeat of the “looking through” excuse we had in 2011 when inflation went above 5%. The truth is that IRs will only be increased when they are forced to; “forward guidance” is now little more than discredited PR.

    If push comes to shove the figures will be rigged as James says above. I’m sure you remember the changes to the unemployment figures thirty years ago when the statistics were continually changed ( I believe around 20-30 times) but in only a couple of cases was the result to increase the unemployment total and there was a deafening silence about the numbers being put on disability benefits.

    What intrigues me is the potential result of the referendum on all this. I think if we vote to Remain, which, despite the polls, I think is still more likely, then that is the worse option. This is because in my view it is bound to go wrong at some stage and, in this case, it will not be possible to blame Brexit but the whole system will be discredited. Second referendum anyone?

    • Second referendum anyone?

      certainly if we vote to leave that has been the modus operandi of the EU/Franko-German Empire.

      within 6 months if not a year


    • The point that you make about Brexit is spot on. If we vote to remain (and I agree with you on the likelihood of that, too), we are then bound into a system with no escape valve. Whatever one thinks about the EU, history suggests that big geographical units formed against the wishes of the population either resort to dictatorships or break up or both. You can see this in the Soviet Union, a number of ex-colonial countries (in Africa and the Middle East), Yugoslavia, Czechoslovakia, etc etc.
      It seems to me that there is a parallel in the way that the EU works and the Ponzi scheme formerly known as European public finances. They both tie us all into a path with fewer and fewer exits, with the inevitable consequences when the dam breaks.

      • A second ( or third) vote is inevitable whichever way this vote goes. If Leave wins, there will be a ‘new deal’ put on the table quite quickly that will lead to vote2. If its Remain, then the federalist timetable will lead to vote2 within the next 5 years.

        • JW

          I agree with you about the second option ( which I think will not be so much about the federal option but the implosion of the Euro and the consequent disintegration of the EU) but not the first.

          What would a second vote after a Leave win mean? That we were “wrong” in principle the first time or “go back and get a better deal”?

      • The USA mostly works, though it did fight a bloody civil war in the 1860s.

        The USA has credible (but not perfect) democracy at Federal level and credible accountability over federal taxpayer spending. The FBI have the power to take on crooked politicians and the politicians do not have immunity.

        If the EU wants to achieve it’s long term goals of peace, prosperity and unity on the continent -> then the politicians will have to reform themselves to add accountability and democracy to Brussels. The goals are admirable – but the practical implementation of the EU is a corrupt, unaccountable and undemocratic mess.

    • Hi Bob J

      I just wanted to repeat what I have replied to Forbin. Last night I watched the National Educational Service episode of Yes Prime Minister from 1988 which refers in its usual combination of jest and truth to the “rebasing” of the unemployment numbers

    • And if leave wins then it is still bound to go wrong as this is about incompetent politicians, not incompetent European politicians.

      The “whole system” will still be discredited , it’s just that the whole system will then be the isolationist UK system and the EU won’t be keen to allow the UK back in, that is, provided the EU hasn’t disintegrated by that time……

      Brexit will not save the UK, rather hasten it’s demise, neither will remain save the UK, rather, it will prolong the eventual collapse. The UK is between a rock and a ….er….rock…….

  4. I believe that one reason that the elite is concerned about 23rd June is that it is also worried about the 26th June, where elections take place in Spain.
    While we wretched Brits have always been a pain to the EU, a second jolt in a week would be unpleasant for our masters in Brussels.

    • Hi James

      That’s a good point as Spain seems to be in a political flux right now. Mind you the European establishment does have one card left to play.

      Panic stations? Jean-Claude Juncker is reportedly set to visit the UK to urge Britons to vote to remain in the EU.

      Mind you which side would be more pleased to see him?

      • Juncker is so impressive that I would have thought a few words from him and Brexit will be all over. He is a titan, a colossus and our grandchildren will speak of him in hushed tones as the father of Europia.
        More seriously, I cannot think of many ways that would more neatly encompass the hubris and complete divorce from reality of the EU if he does come. He is almost the symbol of why to leave – a man who ran Luxembourg as a tax haven and we could not stop from becoming president.

  5. Perhaps we’ll discover that, left alone, the inflation trend we see does indeed dissipate over the next few years as global issues weigh down; we then discover we don’t need a central bank at all…

    • Hi JossB and welcome to my website

      i suspect that the central bankers would be like the Barnacles in Little Dorrit by Charles Dickens.

      “To have got the whole Barnacle family together would have been impossible for two reasons. Firstly, because no building could have held all the members and connections of that illustrious house. Secondly, because wherever there was a square yard of ground in British occupation under the sun or moon, with a public post upon it, sticking to that post was a Barnacle. No intrepid navigator could plant a flag-staff upon any spot of earth, and take possession of it in the British name, but to that spot of earth, so soon as the discovery was known, the Circumlocution Office sent out a Barnacle and a despatch-box. Thus the Barnacles were all over the world, in every direction — despatch-boxing the compass.”

      Bringing this more up to date there was genuine surprise on the face of the President of the Austrian at the most recent ECB Press Conference. It was caused by him being asked if his bank was now irrelevant…..

  6. “Something will have to break…” – Nice one Shaun, didn’t know you were a Joy Division fan. These lyrics could be sung by the Bond market currently:

    “Something must break now
    This life isn’t mine
    Something must break now
    Wait for the time
    Well, something must break.”

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.