Bond Vigilantism Returns to Britain

By Mike Peacock

Bond vigilantism has returned to Britain, prompting concerns that the government may need to contemplate politically sensitive tax increases or public spending cuts to satisfy investors worried about the country’s fiscal health. Chancellor of the Exchequer Rachel Reeves may receive assistance from the Bank of England’s (BoE) balance sheet.

In early 2025, some gilt yields surged to levels not seen since 2008. Although yields have since decreased following unexpectedly low December inflation data, the UK bond market may face significant turbulence in the months ahead.

Market fluctuations reflect a global rise in government bond yields, usually tied to speculation about inflationary policies under U.S. President Donald Trump’s second term. However, UK gilts are reacting more negatively due to fears that the new Labour government’s policies could exacerbate national debt without enhancing economic growth.

Simultaneously, the BoE is continuing its ‘quantitative tightening’ (QT) program by selling gilts, a shift from its previous role as the primary purchaser of UK government bonds. Unlike the Federal Reserve, the BoE is not simply letting debt exit its balance sheet; it is actively reducing its holdings.

The gilt market, worth approximately £2.6 trillion ($3.17 trillion), peaked with the BoE holding around £900 billion. If current QT plans proceed without interruption, this figure may fall to around £560 billion by the end of September.

Expectations indicate the UK will issue around £300 billion in gilts this year, with similar amounts projected for the subsequent fiscal year. At the same time, the bank aims to cut its bond holdings by £100 billion.

Should the BoE halt its QT program, it could effectively decrease the market’s need to absorb gilts by about 30%, potentially applying downward pressure on yields. This would benefit Reeves, who already faces £105 billion in annual debt interest payments—a number that could grow if government bond yields rise, limiting her ability to stimulate the economy.

However, a complete stop to QT seems unlikely. More plausibly, the BoE might slow its bond sales, adopting a passive strategy akin to the Fed’s, which would involve not reinvesting as bonds mature. With around £87 billion in gilts maturing this year, this method could lower gilt sales by about £13 billion over the next year.

Nevertheless, there is a challenge. Recent bond market disturbances have not escalated to the tumultuous levels witnessed during the 2022 crisis under former Prime Minister Liz Truss, largely because Reeves has maintained a clear respect for the central bank’s independence. Truss intended to undermine that autonomy.

Any indication of interference with this independence could shake investor confidence. If the BoE were to intervene, it would need to clearly demonstrate it was acting in accordance with its mandate rather than succumbing to political or fiscal pressures.

One possible justification for intervention could be the need to stabilize market conditions, a responsibility of the BoE. Deputy Governor Sarah Breeden stated that while the bank is closely monitoring the situation, no current issues warrant concern.

Another rationale could be weakened monetary policy transmission. If the BoE cuts rates in February yet market interest rates continue to climb, that could tighten monetary conditions counter to the bank’s intentions.

Simon French, chief economist at Panmure Liberum, pointed out that changes to the QT strategy would not escape controversy, as it could invite political accusations of the bank facilitating a fiscal overreach. Nonetheless, he believes this intervention may be necessary for the UK economy’s well-being.

During the COVID-19 pandemic, the BoE faced allegations of providing political support with its quantitative easing at a time of significant fiscal spending, charges it forcefully denied. A subsequent period of aggressive rate hikes has temporarily quelled that debate.

Having committed to its current bond sale trajectory, the BoE may be hesitant to alter its course. However, in the event of intensified gilt market volatility, it may find itself with no alternative but to act.