World Crisis Online

Hundreds of billions of dollars have exchanged hands this year in bets on when the next interest rate rises will be in the US, UK and eurozone, as volumes have surged in these markets because of the growing threat of inflation.

Financial markets are betting that the UK will be the first to raise rates in June, followed by the European Central Bank in September and finally the US Federal Reserve in December.

Rising food and commodity prices have prompted markets to bring forward expectations of rate rises, sparking the jump in volumes as inflation has become one of the biggest concerns for businesses, consumers and investors.

The increasing focus on inflation has also triggered a debate over the accuracy of these predictions, with opinions divided over how much faith investors should place in them.

Don Smith, economist at Icap, said: “The market forecasts are as good a guide as you will get. They are in a sense . . . multibillion-dollar predictions because of the vast amount of money behind the trades that set them.”

Some strategists also argue that rate forecasts can be self-fulfilling, as central banks do not like to surprise markets.

However, John Wraith, fixed-income strategist at BofA Merrill Lynch, said: “Market rate expectations are useful indicators, but they only tell you the consensus market view at any given point in time. Circumstances change and so do they.”

Mr Wraith thinks rates in the UK, for example, may be delayed beyond June, as policymakers are more concerned about weak growth in spite of rising inflation, which at 3.7 per cent is nearly double the Bank of England’s inflation target. There is also a view that rises in fixed-interest mortgage rates and some company loan costs are in effect tightening monetary policy for the Bank of England, which means that rates may not have to be increased as early as the market expects.

However, most strategists say the markets are more accurate today than they were in the past, as the contracts – known as overnight index swaps in the UK and eurozone and Fed funds futures in the US – used to make the predictions are more widely traded with hundreds of banks and investment funds making bets.

Brokers say rough estimates show daily turnover has risen to about $200bn in Fed funds futures and to about $20bn in each of the UK and eurozone overnight index swap markets.