Bond Vigilantism Returns to Britain

By Mike Peacock

Bond vigilantism has returned to Britain, raising the prospect that the government may need to consider politically toxic tax rises or public spending cuts to placate investors concerned about the country’s fiscal health. However, Chancellor of the Exchequer Rachel Reeves could receive support from the Bank of England’s (BoE) balance sheet.

In early 2025, certain gilt yields spiked to levels reminiscent of 2008. Although yields have since decreased after softer-than-expected December inflation data, the UK bond market appears poised for a turbulent period ahead.

Recent market volatility primarily reflects a global increase in government bond yields, prompted by uncertainties surrounding the potentially inflationary policies of U.S. President Donald Trump’s second term. However, gilts have faced more significant fluctuations, highlighting UK-specific concerns that the new Labour government’s policies may increase debt without enhancing growth.

During this time, the BoE has continued its ‘quantitative tightening’ (QT) program, selling gilts after previously being the main buyer of UK government bonds. Unlike the Federal Reserve, the BoE is actively selling instead of merely allowing debts to roll off its balance sheet.

The gilt market is valued at approximately £2.6 trillion ($3.17 trillion), with the BoE holding nearly £900 billion at its peak. If the current quantitative easing plans persist unchecked, this amount could decrease to around £560 billion by September.

The UK is projected to issue around £300 billion in gilts this year and a similar amount in the next fiscal year, while the BoE aims to reduce its bond holdings by £100 billion. Consequently, the gilt market must absorb about £400 billion over the next year.

If the BoE halted its sales, it would effectively cut supply by 25%, likely reducing yields, which would be favorable for Reeves, who faces annual debt interest payments of £105 billion—an amount that will rise with increasing government bond yields, diminishing her economic resources.

However, given the BoE’s messaging, a complete halt seems improbable. A more likely scenario includes the bank slowing its divestment pace, similar to the Fed’s passive strategy of not reinvesting as bonds mature. Approximately £87 billion of gilts will mature this year, potentially reducing gilt sales by £13 billion over the next twelve months.

Nonetheless, there are complications. Recent bond market fluctuations have not reached chaotic levels, unlike the 2022 UK market meltdown under former prime minister Liz Truss, as Reeves respects the independence of the central bank and the Office for Budget Responsibility. Any suggestion of infringing on this independence could upset investors.

Thus, if the BoE acts, it must demonstrate that its actions align with its mandate and not political or fiscal pressures. One potential justification could be market instability, as BoE Deputy Governor Sarah Breeden stated the bank was closely monitoring the situation without current cause for concern.

Another motive could center on impaired monetary policy transmission. For example, if the BoE reduces official rates but market interest rates continue to rise, it tightens monetary conditions counter to its objectives.

Simon French, chief economist at Panmure Liberum, remarked that a shift in the QT program would attract political accusations and claims of financing fiscal overstretch, despite being beneficial for the UK’s economy.

The BoE faced similar accusations of aiding the government during the pandemic, which they firmly contested. The debate subsided temporarily due to a subsequent cycle of aggressive rate hikes. Now, although committed to its bond sales, the BoE may have no alternative but to rethink its stance if gilt market volatility escalates.

($1 = £0.8195)