UK Gilt Yields and Bank of England Interest Rates

Investing.com – UK gilt yields have soared recently, which has solidified UBS’s view that the Bank of England will cut interest rates in February, with more cuts expected later this year.

The rise in UK yields began alongside the increase in US yields following the US election, but UK-specific concerns became prominent only last week, according to UBS analysts in a note dated January 13.

The recent budget, which included business-focused tax increases, has shattered already fragile confidence. In Q3 2024, growth fell short of expectations, and this weakness is likely to persist in the near term.

UBS noted that the larger issue is the minimal fiscal headroom left to address unforeseen challenges, as illustrated by the recent higher yields. The added cost of servicing the UK national debt may affect the Chancellor’s fiscal targets when the Office for Budget Responsibility releases its Spring Statement, an issue that Rachel Reeves may need to address.

The Chancellor has currently ruled out tax increases in the spring, leaving spending cuts as the alternative. However, implementing these cuts may be more challenging than anticipated. The budget’s hallmark was a significant increase in public spending, which is why there’s little fiscal headroom despite substantial tax rises. The real question now is whether the Chancellor is willing to reverse this trend or if he will merely promise future cuts on top of already ambitious plans to reduce spending growth for the rest of the parliament.

UBS speculated that the Chancellor might choose the latter option, leaving investors wondering whether they will be convinced by these promises.

Nonetheless, recent developments suggest that the Bank of England may not remain inactive. Rising borrowing costs impacting the real economy are tightening financial conditions. Although inflation pressures are present, they are diminishing, leading to a base case of a rate cut in February, with additional cuts later this year.