UK Traders Bet Big on Bank of England Rate Cut, Despite Inflation Surge

Some traders in the UK options market have placed bets that the Bank of England will cut interest rates significantly this year, despite inflation being at an 18-month high. These bets could yield returns exceeding 1,000% if the central bank's actions align with their predictions.

On Thursday, traders purchased options strategies linked to the overnight index average rate, which serves as a proxy for the policy rate. The initial investment for this bet was approximately 1.5 million pounds. If the benchmark rate falls to 3.5% by the end of the year, which is 25 basis points lower than the current market expectation, the return could be around 20 million pounds, or 26.8 million dollars.

The high potential returns from these bets are due to their contrarian nature. This week, market expectations for a rate cut by the Bank of England have cooled following stronger-than-expected inflation and wage growth data. The market no longer anticipates three 25 basis point rate cuts by the end of the year, which was previously seen as a 20% probability just a week ago. Similar high-return bets were made in May, targeting a rate of 3.25%.

Despite the surprising inflation data, the Bank of England's governor has indicated that more aggressive rate cuts could be implemented if the labor market deteriorates faster than expected. This has kept hopes alive for significant rate cuts.

Macro strategists have noted that rate traders may be overestimating the extent of the Bank of England's potential easing, which could lead to disappointment. To avoid substantial losses on one of these trades, the Bank of England would need to lower the benchmark rate to at least 3.75%.

Options trading is typically conducted anonymously, making it difficult to identify the institutions or individuals behind these trades. Meanwhile, data released on Tuesday showed that tariff costs are contributing to price increases, exacerbating concerns about inflation in the United States. The probability of two rate cuts by the Federal Reserve this year has been reduced to 75%, down from a complete expectation of a half-percentage point cut just a week ago.