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UK bond market review (September 2017)

Gilt yields soar in September

Gilt prices fell and yields surged amid mounting expectations of an increase in UK interest rates – perhaps as early as November – and a strong increase in inflationary pressures. Earnings growth continued to lag inflation; average earnings excluding bonuses rose at an annualised headline rate of 2.1%, but fell by 0.4% in real terms.

  • Consumer price inflation hit 2.9% YoY in August
  • The UK economy grew by 1.5% YoY in the second quarter
  • Credit ratings agency Moody’s cut the UK’s credit rating from Aa1 to Aa2 in September

“Looking ahead, the members of the MPC expect inflation to breach 3%”

Gilt yields surged during September and prices fell amid expectations of higher interest rates. Over the month, the yield on the ten-year gilt soared from 1.09% to 1.41% , while the short-dated gilt yield climbed from 0.18% to 0.54%.

Speculation over the possibility of monetary tightening was stoked by comments from the Bank of England (BoE). Despite leaving base rate at 0.25% for another month, the Monetary Policy Committee (MPC) expects “some withdrawal of monetary stimulus… over the coming months”. This could take place as early as November. Looking ahead, the members of the MPC expect inflation to breach 3% during October, compared with a government-set target rate of 2% . Meanwhile, the UK’s annualised rate of inflation reached its joint-highest level since June 2013 during August. The Consumer Prices Index (CPI) rose to 2.9% during the month, compared with 2.6% in July, stoked by higher prices for energy and for clothing and footwear. CPIH – the “official” measure of inflation, which includes owner-occupiers’ housing costs – rose from 2.6% to 2.7%.

The rate of unemployment fell from 4.4% to 4.3% in the three months to July. However, earnings growth continued to lag inflation: average earnings excluding bonuses rose at an annualised headline rate of 2.1%, but fell by 0.4% in real terms. Elsewhere, the UK economy grew less rapidly than previously calculated during the second quarter, expanding at an annualised rate of 1.5% compared with an earlier calculation of 1.7% , and dampened by slowing household spending. The updated figure represents the UK economy’s slowest year-on-year growth since the first quarter of 2013.

The British Chambers of Commerce (BCC) warned that there was “no sign… of a return to healthier levels of growth” in the UK economy, and trimmed its forecast for economic growth in 2018 from 1.3% to 1.2%, citing a deteriorating contribution from net trade and expectations of a slowdown in consumer spending growth.

Credit ratings agency Moody’s cut the UK’s credit rating from Aa1 to Aa2 in September and downgraded its outlook from “stable” to “negative”. The agency queried the strength of the UK’s public finances and highlighted uncertainties over Brexit’s impact. In particular, Moody’s is pessimistic over the UK’s chances of securing a replacement free trade agreement with the EU. Moody’s previously downgraded the UK from its coveted triple-A rating back in February 2013.

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