(Bloomberg) – Investors emboldened by the Bank of England’s unexpected tilt this week are stocking up on British government bonds as anxiety over the inflation outlook begins to give way to worries about Economic Growth.

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Five-year gilts – among the most sensitive to policy shifts – posted their strongest two-day advance since Russia’s invasion of Ukraine on Friday, driving gains among their peers. BMO Global Asset Management says UK government bonds could continue to outperform Treasuries and German debt. For AllianceBernstein, which had strengthened its position in British assets, the short end of the curve is attractive.

Policymakers surprised investors on Thursday by pointing to the risks that soaring energy prices pose to household incomes, prompting markets to backtrack on aggressive interest rate hikes this year. Prior to the decision, an unusually large 50 basis point rise in upcoming meetings was all but certain for the market, with expectations leading to a sell-off that pushed five-year yields to the highest since 2015 last month.

Today, with the momentum of an aggressive tightening pace fading as Russia’s invasion of Ukraine adds to a bleaker growth picture, UK bonds appear to have found a net of relief. security. This is even as investors brace for an acceleration in inflation over the next few months and the government announces on Wednesday a new gilt supply for the coming fiscal year.

“If things go wrong in terms of the growth outlook, then the five-year part of the curve could do very well because it will react well to the market pricing in those interest rate hikes that it’s spent a long time pricing in,” said John Taylor, portfolio manager at AllianceBernstein.

The shift in sentiment shows how quickly the tide can turn if central banks return to supporting their economies. The change is all the more impressive as the BOE was the first of the major central banks to start raising interest rates this cycle.

The European Central Bank surprised investors with a faster exit from the stimulus earlier this month, despite being more exposed to the economic fallout from the war in Ukraine. The Federal Reserve also responded to market expectations for an aggressive tightening cycle this year in its so-called dot chart, which it uses to signal its outlook on the path of interest rates.

“Over the past six to eight months, the BOE has definitely been seen as a frontrunner when it comes to price size,” said Chris Lupoli, rate strategist at BNP Paribas. “It looks like the warmongering mantle may be being put back on the other side of the Atlantic.”

Money markets are pricing around 120 basis points in rate hikes from the BOE, up from 143 basis points before its decision this week.

Emphasis bias

Since Wednesday’s close, the yield on five-year debt has plunged some 16 basis points. The bias towards shorter-term debt has also steepened the yield curve, with the spread between two- and 10-year yields widening to around 30 basis points from less than 10 basis points a year ago. a week old.

This trend could continue, according to James Lindley, portfolio manager at BMO Global Asset Management, as the BOE’s less aggressive stance on inflation prompts investors to reconsider holding longer-term debt. Next week’s data could serve as yet another reminder of soaring price growth, with headline inflation set to accelerate to 6% in February, the highest since 1992.

The Debt Management Office is set to announce its gilt issuance plans for the coming fiscal year next week. The sales will not be cushioned by the BOE’s bond purchases, which ended in December, and could weigh on longer-term debt relative to shorter-term debt, according to the portfolio manager of Aegon Asset Management, James Lynch.

Yet bonds may still look attractive to investors who fear central banks may have no easy way out of the combination of rising prices and slowing growth. Waiting too long to tighten policy risks fueling inflation, while turning to further hikes now is an additional headwind for growth.

With yields rising in recent months, that provides a “cushion” against the risk of central banks becoming hawkish again, AllianceBernstein’s Taylor said.

“It is undeniable that central banks are in a rather difficult position, so the likelihood of policy errors increases,” he added. “Now that we’ve reached higher levels of return, I think bonds offer some protection against these unpleasant risk events.”

Next week

  • There is a large list of speeches from policymakers scheduled, including ECB President Christine Lagarde and BOE Governor Andrew Bailey

  • Economic data is also busy with UK inflation and German Ifo figures. PMI figures are expected from both countries as well as France and the eurozone

  • UK Chancellor Rishi Sunak makes his budget statement on Wednesday when the Golden Mandate will also be released

  • Debt sales are due from Germany, the Netherlands, Belgium and Italy for a total of about 12 billion euros ($13.3 billion), according to Commerzbank AG

  • EU set to sell new 10-year bond via banks for up to €8bn, says Danske Bank A/S

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