The recent rises in 2-year and 10-year gilt yields to their highest levels since the “dash for cash” at the start of the pandemic have entirely been driven by the investors revising up their expectations for inflation. Indeed, 10-year break-even inflation rates are now at their highest level since the Global Financial Crisis (GFC). Our forecast that RPI inflation will shoot up from 3.8% in August to just over 6.0% by the end of the year suggests that break-even inflation rates may yet rise further. But they should then drop back next year as the bulk of the rise in RPI inflation is reversed. What’s more, our view that the Bank of England will put more weight on the recent weakening in activity than the rise in inflation and won’t raise Bank Rate until 2023 suggests that a big surge in nominal gilt yields is not around the corner.
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