Long bond yields have been on the increase in the UK, US and Continental Europe for some months now. There are several possible explanations. One is increased supply of bonds, which has lowered prices and raised yields in the euro markets. Another, in the UK, is that the likelihood of euro membership has receded, diminishing the chances of convergence to what were, six months ago, lower euro area rates. But the standard explanation for higher bond yields is that investors' expectations of future inflation have taken a turn for the worse.
This was, perhaps, inevitable after a period of such favourable inflationary conditions. As the impact of the Asian crisis recedes, the one-off benefits of lower commodity and goods prices will also fade away. The US still has the benefit of a strong dollar holding import prices down, so that the inflationary pressure is showing up in its alarmingly wide trade deficit, but the exchange rate effect in the UK has started to go into reverse.
In the short term inflation figures in the UK are likely to turn out to be extremely favourable. However, the MPC is supposed to be aiming at inflation 18 months to 2 years ahead. Interest rates are probably at their low point, even if they do not have to rise for some months yet. Mortgage rates are already passing their trough.Reuse content