(Bloomberg) -- A global bond rally ignited by signs that inflation in the world’s largest economy is finally slowing once again faces a reality check this week.

Government debt from around the world is enjoying its best month of the year after a gauge of price pressures in the US last week ebbed for the first time in six months. At home, that’s encouraged bets that interest-rate reductions by the Federal Reserve are just around the corner — and elsewhere, it’s reassured investors that their central banks also have room to cut. 

Bond markets were quiet as the week kicked off, with US Treasuries and European bonds little changed early on Monday. But moves may pick up later in the day, when a series of Fed officials including Raphael Bostic and Christopher Waller are due to speak. 

In Europe, attention is turning to an inflation report in the UK. While prices there have moderated significantly since late 2022 — when the inflation rate hit a heady 11.1% — investors warn the downward path for prices isn’t plain sailing. For markets, it’s the latest checkpoint in a bumpy journey to find out if the global fight against historic levels of inflation is finally nearing an end.

“Next week’s UK CPI print will be important, and we see a risk that this declines by less than many have hoped for,” said Mark Dowding, chief investment officer at RBC BlueBay Asset Management, commenting on Friday. “This could place enthusiasm for rate cuts onto more of a back burner.”

A near-euphoria has rippled across markets in recent days, predicated on the notion that the era of aggressive price pressures is ending. Indeed, a report due Wednesday is expected to show UK inflation slowed from 3.2% to 2.1% in April, within a whisker of the Bank of England’s official target. 

But a hotter-than-expected figure could lead traders to dismantle recent bets on a rate cut from the BOE as soon as June — and call into question whether investors around the world have gotten ahead of themselves. 

What Bloomberg Strategists Say:

“The crucial takeaway will be the evolution of inflation beyond the spring. Core and services inflation for April are expected to stay sticky at higher levels, so the head room for the BOE to cut interest rates is minimal.” 

— Ven Ram, a cross-assets strategist for MLIV in Dubai

Money-market pricing in the UK currently implies a 50% chance of a quarter-point reduction next month, and two in total this year. In the US, traders see a 70% probability of a cut in September. And in Europe, a June cut is all but certain, swaps pricing suggests. German bonds were also little changed on Monday.

“In the UK, it’s not that we have good evidence that inflation expectations are unanchored, but if there is a risk of them being unanchored anywhere, the UK would be it,” said Ralf Preusser, global head of G-10 FX and rates at Bank of America Corp. He recommends betting against UK real rates versus France, on the basis that the euro-zone economy faces lower inflationary risks.

Read more: Traders Ramp Up Bets in Options Market on Large ECB Rate Cuts

While the UK’s benchmark 10-year bond yield fell for a third straight week through Friday, the longest streak of declines this year, the UK’s outlook has been holding gilts back from a major rally of the kind experienced by Treasuries.

US bonds have been on a tear, with 10-year yields down more than 30 basis points from their year-to-date high, trimming losses for the market this year to about 1.4%. By contrast, a Bloomberg index tracking gilts remains down more than 2% this year. 

“It is too soon to be long UK gilts at the current juncture because services inflation remains much too sticky,” said Chester Ntonifor, a strategist at BCA Research.

What to Watch:

  • In the US, key data includes S&P Global US manufacturing, services and composite PMIs, jobless claims (May 23), durable goods orders, University of Michigan sentiment (May 24)
  • Minutes (May 22) from the Federal Reserve’s last policy meeting will offer insight into the decisions taken at the May 1 gathering, when Chair Jerome Powell effectively ruled out further rate hikes
    • Bloomberg Intelligence expects the minutes to show that “several” officials think favorable supply-side factors will allow inflation to fall without much of a cost in employment
  • In the euro area, flash PMI survey for May (May 23) will give an insight into how growth is developing in the second quarter
  • The European Central Bank’s indicator of negotiated wage rates (May 23) will provide the first publicly released estimate of the increase in pay settlements for the euro area in the first quarter
  • Inflation data will be among the key pieces of data for the UK (May 22), while the UK flash composite PMI (May 23) will likely signal that the economy maintained a healthy rate of expansion in 2Q24

--With assistance from Michael Mackenzie.

(Updates with additional context in third paragraph.)

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