Some normality has returned to UK gilt yields after inflationary pressures dipped and political fears eased.
- The UK 10-year gilt has now come down to 4.87%
- The immediate catalyst for the reversal was weaker-than-expected inflation data
- The UK political situation has also stabilised
The UK gilt market has dodged another bullet, with yields seeing their biggest weekly drop in three years. The UK 10-year gilt has now come down to 4.87%, having reached as high as 5.2% in the height of the political crisis engulfing the UK. They have delivered a warning shot to any politician who would seek to defy them, and gilt markets can now return to normal.
The immediate catalyst for the reversal was weaker-than-expected inflation data and slowing business activity. This makes it more likely that the Bank of England would look through higher energy prices and keep rates on hold for the foreseeable future.
The UK political situation has also stabilised somewhat. Prime ministerial wannabe Andy Burnham has assured markets that he will stick to Rachel Reeves’ fiscal rules, even though any suggestion that he would do otherwise was implausible. Every leader faces the risk that interest costs grow exponentially – the more they seek to break the rules, the more will go on debt interest and the less is available for teachers, nurses or infrastructure spending. There is only so much can be raised in tax – and certainly not enough to cover ever-rising debt interest.
However, the biggest problem remains the war in Iran. That shifted the 10-year gilt yield from 4.2% to around 4.9%. The political crisis only took it a little higher – to 5.2%. As there have been tentative signs of a peace deal, the yield has edged lower. However, it will take more permanent signs of an easing of energy costs for markets to be fully reassured and for gilt yields to drop back to the levels seen at the start of the year.
Global bond markets remain fragile. The 2-year Treasury yield is still hovering at 4.04%. This is above the Fed’s own upper limit of its short-term policy rate. The Fed meets on the 16-17 June, under the stewardship of Kevin Walsh. While few expect an immediate hike, the mismatch suggests that bond markets still believe that there is a real chance of interest rate hikes later this year. Any rate rises from the Federal Reserve would put other central banks on notice.
UK borrowers can breathe a short-term sign of relief. However, pressures remain – both from the war in Iran and the activity in global bond markets. Until policymakers look to shift the make-up of gilt buyers, UK gilts remain vulnerable to external pressure from wherever it materialises.
