Rates and foreign exchange markets are adjusting to a less hawkish Bank of England reality.

　　Sterling has begun to react to weaker consumer data, and risks appear to be skewed to the downside, barring a very hawkish surprise.

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　　The Bank of England is expected to hike in May and June, but the tone is becoming more cautious. The BoE's voting pattern and lower growth forecast should be indicators that front-end hike expectations are excessive. We expect markets to adjust to a less hawkish reality as the central bank hits the pause button in the summer.

　　The coal mine's golden canary

　　After months of leading the sell-off in the core rates market, with a clear underperformance in the second half of 2021 relative to US Treasuries and German Bunds as the Bank of England increased its hawkish message, gilts are now warning that the sell-off is losing steam. A string of weak sentiment data caused the market to re-rate recession probabilities, lending credence to the BoE's relatively cautious tone.

　　While the possibility of 10Y gilts breaking the 2% barrier to the upside remains, we expect them to continue to lag the Bund and USTs if bond selling resumes. We forecast that yields will end 2022 at 1.8 percent, and that the rally will pick up steam next year. Additionally, we caution that the Bank of England's impaired liquidity conditions in the gilt market make outright selling less likely in the near term.