That concludes our coverage of the UK gilt market today. Thank you for following along with us. We will be back with more live analysis on markets, inflation and interest rates in the coming weeks, with a special focus on the US in the lead-up to Trump’s return to office.
“We think that bonds will recover before long”
The selloff in the UK government bond market has sparked further criticism of Reeves’ Autumn Budget this week. However, experts at consultancy Capital Economics have called the latest developments a “global bond market storm in a British teacup”.
“We think that bonds will recover before long, with yields falling back more in the UK than elsewhere,” says Hubert de Barochez, senior markets economist at the consultancy.
“One reason is that we expect Trump to fail to cut taxes as much as planned, and therefore that worries over US public finances will abate a bit,” he adds. “What’s more, with inflation near to target in most places, central banks have more room to cut rates if necessary.”
Although UK markets are only pricing in one or two base rate cuts in 2025, most economists think this stance is overly cautious. Capital Economics thinks inflation will fall more quickly than currently forecast and, as a result, expects the base rate to reach 3.5% by early 2026.
“This is why we forecast the 10-year gilt yield to fall back to 4.0% by the end of the year, from roughly 4.8% now,” de Barochez explains.
Mortgage costs unlikely to fall any time soon
The start of the year can sometimes be a good time to shop around for a mortgage deal. That was certainly the case last year, when lenders sparked a pricing war as they jostled with one another to attract customers with lower rates.
The start of 2025 looks a little different, though. Ben Thompson, deputy chief executive at Mortgage Advice Bureau, expects mortgage rates to “rise in the near term at least”.
He says: “Some of the factors underlying the recent spike may well soften soon, but it has felt for a while that inflation would persist at a slightly higher level than targeted and as such the cost of borrowing would remain broadly at current levels and isn’t about to fall meaningfully anytime soon.
“What we have seen is the market gradually adjust to a higher rate environment in part helped by wage growth and that means that those who have waited to buy or move home for a few years will now just want to commit and get on with it, as opposed to waiting for mortgage rates to drop much further.”
Do higher gilt yields point towards stagflation?
The nightmare scenario is that elevated UK government debt hinders the government’s ability to kickstart growth in the economy, and coincides with an inflationary environment – a combination that economists call ‘stagflation’.
“There is also particular concern brewing about stagflation taking hold, given that inflation has been creeping up and pay growth is still hot, while the economy has been stagnating,” says Susannah Streeter, head of money and markets, Hargreaves Lansdown. “It’s unclear to what extent the UK government’s investment in infrastructure will provide a boost to growth over the longer term.”
Streeter adds: “it seems appetite to buy long-term dated UK government debt has fallen amid the increased uncertainty gripping global bond markets.”
Are higher gilt yields good news for annuity rates?
Many savers who are approaching retirement have a large allocation to bonds in their portfolio – part of their de-risking strategy. Their portfolios may have suffered losses recently as a result of the selloff in gilt markets.
However, there could be some good news for older savers on the cusp of purchasing an annuity with their pension savings.
“The surge in gilt yields could push up annuity rates in the coming weeks,” says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown. “It would add a further boost to a market that has enjoyed enormous growth in recent years.”
She explains that a 65 year-old with a £100,000 pension could currently get up to £7,235 per year from a single life level annuity with a five year guarantee. “We could see this increase further from here,” she adds.
Gilts and Treasuries joined at the hip
Underscoring the point about gilts and Treasuries (the US equivalent) is this chart from AJ Bell, based on Refinitv data:
That’s not to say that the ramifications are the same, though.
“The US has the benefit of being the world’s reserve currency, which underpins demand for dollar denominated assets such as US Treasury bonds,” says Laith Khalaf, head of investment analysis at AJ Bell. “Here in the UK, higher yields put pressure on government finances and increase the risk that Reeves will come back with another tax raising Budget.”
Every cloud has a gold lining?
While the surge in gilt yields has caused a headache for the government and some investors, it has meant good news for the gold price. Up 37.5% compared to this time last year, the gold price is now £2,172 per Troy ounce – a new GBP record.
“Because gold pays no interest, it usually falls in price when bond yields rise,” says BullionVault director of research Adrian Ash. “Gold rising together with government borrowing costs signals how uneasy the markets are becoming over the UK's budget deficits and long-term debt.”
What do higher gilt yields mean for the pound?
It’s a pretty miserable time for sterling.
“Typically, higher inflation expectations or a hawkish adjustment to the BoE policy stance drive yields higher, and that is bullish for the pound,” says Kyle Chapman, FX Markets Analyst at Ballinger Group. “In this case, the move is driven not by the macro data, but by heavy gilt supply, concerns about the UK government’s debt sustainability, and the inflationary impacts of the extra fiscal spending in the pipeline.”
This has seen the pound fall by fractionally under 1% against the dollar earlier this morning, though it has since recovered some of these losses.
As Saravelos says, though, the pound’s fall is an important mechanism through which the gilt market can stabilise.
Mortgage rates could rise thanks to surge in gilt yields
When setting mortgage rates, lenders pay close attention to a range of factors including swap rates. These are closely linked to gilt yields. As a result, the latest increase in gilt yields does not bode well for those hoping to see mortgage rates fall further.
The average two-year fixed mortgage rate is currently 5.47%, according to comparison site Moneyfacts. The average five-year deal is 5.25%.
2022 all over again?
It doesn’t take a particularly long memory for today’s events to recall the last time rising gilt yields threw the UK government into chaos.
Liz Truss’s infamous ‘mini-budget’ of September 2022 sent gilt yields up 1.2% within days of its announcement. This ultimately forced Truss to resign.
“Today, the UK’s demons are back, driven by heightened fiscal concerns – evoking memories of Liz Truss’s chaotic 'mini-budget’ days,” says Ipek Ozkardeskaya, senior analyst at Swissquote Bank. “Back then, markets lost confidence in the government’s spending plans, triggering an aggressive selloff that forced the BoE to intervene.”
However, George Saravelos, global head of FX research at Deutsche Bank, thinks the two gilt yield crises are distinct from one another.
“The 2022 crisis was self-inflicted,” he says. “It was a UK-driven policy shock. The easiest way to see this is that gilt moves back then completely decoupled from other markets and idiosyncratically sold off.
“This time round, all gilts are doing is mirroring US treasuries. The most straightforward way to demonstrate this is that the 10-year UST - Gilt spread is moving sideways and is exactly where it was six months ago.”
The bad news, though, is that “precisely because recent market volatility is not self-inflicted there is no easy way out”.
Saravelos argues that because the UK relies relatively heavily on foreign financing for its domestic debt, gilts are more exposed than other developed economies’ bonds to US Treasury sell-offs.
“The chancellor and central bank have an important job to do,” says Saravelos. “The Bank of England needs to maintain the credibility of the inflation target. The chancellor needs to signal sensitivity to the worsening global environment by potentially paring back some spending. Both need to avoid any signal of fiscal dominance.
“But beyond a few tweaks here and there, it is largely the currency that will do the work of stabilizing the bond market combined with an eventual peak of US yields.”
An opportunity for bond investors?
Is the latest spike in yields good or bad for bond investors? It largely depends on whether you are an existing bondholder or someone eyeing up new opportunities in the market.
Bond yields and bond prices have an inverse relationship, so when one rises, the other falls. Investors have been selling UK government bonds recently in response to the latest risks, and this has pushed yields up.
Those with gilt investments will have experienced some recent losses as a result of the latest developments. “The typical gilt fund is down 2.5% in the last three months, while the typical pension lifestyling fund is down 4.4%,” according to Khalaf.
The flipside is that the yields spike is creating income opportunities. “Fresh bond investors might be licking their lips as yields rise and they are able to lock into higher rates,” Khalaf adds.
Taxes to increase?
The fear is that increased borrowing costs will force the government either to raise taxes, or to cut back on public spending in response, having just raised taxes in the Autumn Budget in order to cover the so-called fiscal black hole.
“Higher yields put pressure on government finances and increase the risk that Reeves will come back with another tax raising Budget,” says Khalaf.
Over the long term this could impact the UK’s growth prospects.
“Weak demand for UK debt raises the risk of either government spending cuts or further tax hikes to balance the country’s finances, neither of which would be positive for growth,” says Ryan.
Treasury response
A spokesperson for HMT responded to MoneyWeek with the following statement:
“No one should be under any doubt that meeting the fiscal rules is non-negotiable and the Government will have an iron grip on the public finances.
"UK debt is the second lowest in the G7 and only the OBR’s forecast can accurately predict how much headroom the government has – anything else is pure speculation.
“Kick-starting economic growth is the number one mission of this Government as we deliver on our Plan for Change. Over the coming weeks and months, the Chancellor will leave no stone unturned in her determination to deliver economic growth and fight for working people.”
The Treasury also iterated that “the current budget deficit is forecast to be £55.5 billion in 2024-25. From then, it improves in every year until 2027-28 when the current budget is in surplus”.
The spokesperson said that Reeves will “deliver a speech in the coming weeks on the Government’s economic strategy and plan for growth”, but did not respond to a question on whether or not she will address Parliament on the matter today. This appears unlikely given her scheduled trip to China.
Why are gilt yields rising?
Unsurprisingly, politicians have traded barbs over who is to blame for the increase in gilt yields in Parliament this morning.
Conservative MPs blamed Reeves’ Budget for spooking bond markets, while Labour MPs have attempted to push the blame back onto the previous Conservative government for running up the “black hole” that forced Reeves into tax rises.
Financial analysts also appear split on the matter.
Matthew Ryan, head of market strategy at Ebury, views the yields spike as “a damning indictment of Labour’s fiscal policies”. Ryan singles out the increase to employer NI contributions “which businesses have already warned will lead to higher prices and a worsening in labour market conditions”.
Laith Khalaf, on the other hand, points to the fact that bond yields have been rising in the US and the UK over recent months, and thinks that this week’s spike is more due to the potential impact of Donald Trump’s incoming presidency.
“The fact yields are rising on both sides of the Atlantic does suggest the new year has brought with it a focus on the incoming US president, and the potential for his trade and immigration policies to be inflationary,” says Khalaf.
Mike Riddell, portfolio manager, Fidelity International, seems to agree: “A common conclusion is to point fingers at the government. But this would miss the point; it is mainly a global fixed income story. UK gilt yields are broadly moving with US Treasuries.” He also points to similar moves in long-dated German government bonds over the past month.
The background
Gilt yields – effectively, the interest rate the UK government pays on its debt – have skyrocketed over the last two days to their highest level since the financial crisis.
This puts chancellor Rachel Reeves in a tight spot. Her Autumn Budget – barely two months old – risks unravelling as the costs of servicing UK government debt soar.
Shadow chancellor Mel Stride has called Reeves to address the House of Commons on the crisis this morning. However, at the time of writing, it looks as though Reeves is pressing ahead with a planned trade visit to China instead.
Good morning, and welcome to MoneyWeek’s live blog covering today’s big financial news: the spike in gilt yields that threatens to upend chancellor Rachel Reeves’ Autumn Budget just months after it was announced.
Dan McEvoy and Katie Williams here to take you through the news as it develops.