European ETF provider Lyxor has launched a new fund providing investors with exposure to UK inflation expectations. The Lyxor UK£ 10Y Inflation Expectations UCITS ETF (LON: UKBE) targets the spread between traditional bond yields and those of inflation-linked bonds, thus offering a pure play on inflation expectations without exposing the investor to changing interest rates.

The ETF will appreciate in value if market expectations for UK inflation increase.

The ETF tracks he Markit iBoxx GBP Breakeven 10-Year Inflation Index which is representative of the performance of a long position in six issuances of UK index-linked gilts having durations closest to 10 years, and a short position in nominal UK gilts with adjacent durations. The difference in yield between these bonds is commonly referred to as the “breakeven rate of inflation” and is considered to be a measure of the market’s expectations for inflation over a specified period of time.

An increase in inflation expectations will translate to an increase in the value of the ETF, as rising inflation expectations cause the yield on non-inflation protected bonds to rise and their price to fall, thus increasing the value of the short position in the portfolio.

This methodology is different to a long-only position in Treasury Inflation Protected Securities, which provide a hedge against inflation, but which, like any bond, are likely to fall in value if rising inflation expectations were to translate into higher interest rates. The ETF may be well suited as a simple overlay to an existing bond portfolio that requires an inflation hedge. The ETF has a total expense ratio of 0.25%

Last year Lyxor launched the Lyxor USD 10Y Inflation Breakeven UCITS ETF (INFU) and the Lyxor EUR 2-10Y Inflation Breakeven UCITS ETF (INFL) which track inflation expectations in the US and Europe respectively (see: Lyxor launches first UCITS ETFs to track inflation expectations). The funds have proven popular of late, with both funds seeing a surge in AUM since the US elections. As of 13 March, INFU had  $560 million AUM and INFL had €350m AUM.

The launch comes at a time when the Retail Price Index (RPI) hit 2.6% in January, its highest rate for two and a half years. As the UK comes out of the monetary expansion phase seen since the financial crisis, the timing of future actions by the Bank of England will be key to setting the market’s inflation expectations.