Increased political noise around a potential leadership challenge for the UK Prime Minister is creating a risk premium in the market. A poor performance by the Labour party in a specific upcoming by-election could accelerate this challenge, leading to further underperformance of UK gilt yields versus German bunds.
Despite market focus on potential changes to the ECB's repo and swap lines, such as extending their duration and size, analysts expect minimal market impact. This is because borrowing at these liquidity facilities has been very low, currently at zero, diminishing the real-world effect of any extensions.
Analysts are cautious on intra-EMU carry trades because spreads are too tight. The low carry, or "skinny carry," provides an insufficient cushion against external risk-off events, which can wipe out months of gains. The advice is to await wider spreads before re-entering these crowded positions.
The Bank of England's dovish 5-4 vote to hold rates conflicts with its more cautious forward guidance. This mixed messaging suggests a near-term rate cut is likely but creates significant uncertainty about subsequent easing, which will limit the total number of cuts the market can price in for the year.