Gradual tightening strategy remains intact

UK government bond yields fell over the first six months of 2019, boosted by rising demand for gilts driven by political uncertainty. Despite signs of increasing dovishness amongst central bankers in the US and Europe, the Bank of England is still expected to tighten interest rates gradually over the next two years.

  • The Chancellor of the Exchequer warned about the threats posed by no-deal Brexit
  • The UK economy contracted in April
  • The manufacturing sector contracted for the first time since July 2016

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UK government bond yields fell over the first six months of 2019, boosted by rising demand for gilts driven by political uncertainty. Over June, the yield on the benchmark UK government bond fell from 0.87% to 0.79%, having begun 2019 at 1.26%. The yield on the short-dated gilt eased from 0.62% to 0.60%, having started the year at 0.76%.

“This is a moment when a stitch in time, interest-rate wise, could save nine” (BoE Chief Economist Andy Haldane)

In the annual Mansion House speech, Chancellor of the Exchequer Philip Hammond warned that “a damaging “no-deal” Brexit would cause short-term disruption to our economy, soaking up all the fiscal headroom we have built and more”. He set out a choice between “no deal” and the preservation of the UK’s future fiscal space, warning: “we cannot do both”. 

The UK economy shrank at a month-on-month rate of 0.4% in April; over the three months to the end of April, the economy grew by 0.3%, compared with 0.5% over the three months to the end of March. Activity was undermined by a “dramatic” decline in car production and a moderation in manufacturers’ stockpiling activity following the extension to the Brexit deadline from the end of March to the end of October. 

The UK’s manufacturing sector shrank during May, posting its first contraction since July 2016, according to IHS Markit/CIPS, as stockpiling activity dwindled in the wake of the original Brexit deadline. Manufacturing firms reported problems persuading clients to commit to new contracts, and new business volumes fell for the first time in seven months. Brexit-related uncertainties appear to have affected the sector, and some clients have diverted their supply chains away from the UK.

Despite signs of increasing dovishness amongst central bankers in the US and Europe, the BoE is still expected to tighten interest rates gradually over the next two years. During the month, Monetary Policy Committee member Michael Saunders said that “further monetary tightening is likely to be required over time”, although he reiterated that any tightening could be “limited and gradual”. Meanwhile, in an article published during June, BoE Chief Economist Andy Haldane said: “For me personally, the time is nearing when a small rise in rates would be prudent to nip any inflationary risks in the bud … this is a moment when a stitch in time, interest-rate wise, could save nine”. UK base rate has remained at 0.75% since August 2018.


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