UK linkers’ impressive rally might lose steam next year

Inflation-linked bonds in the United Kingdom has staged an impressive rally this year, especially after the people of the United Kingdom voted in favor of an exit from the European Union and the pound lost more than 15 percent of its value against the dollar. A rise in inflation expectations has led a rush among investors to hold the inflation-linked securities in the United Kingdom. The 10-year break-even rate of inflation has reached the highest level since 2014 at 3.01 percent. Back in the summer, it was hovering just around 2.2 percent.

A recent survey by Citi/YouGov shows that the long-term inflation expectations have jumped to 3 percent, while consumers are expecting an inflation of 2.43 percent over the next 12-months. The Bank of England (BoE) has itself forecasted an inflation rate of 2.7 percent for next year in its latest inflation outlook. As the central bank launched an array of measures in August that includes almost £170 billion balance sheet expansion in response to the referendum outcome, Gilts have outperformed its other sovereign peers returning almost 9 percent so far.

However, the linkers have outperformed gilts by more than 2 times. This year UK linkers have returned around 21 percent. And that is worrying some analysts and investors, who suggest that the linkers have gained a lot and too fast, which may not reflect fundamental valuations. According to the group, the impressive rally in the linkers could ease next year as the changed in the inflation outlook and in other fundamentals remain largely priced in.