UK Government Bonds Sell Off Dramatically

UK government bonds, known as gilts, have experienced a significant sell-off over the past week, raising associated yields to their highest levels since 2008 and increasing pressure on the new Labour government as it attempts to stimulate the sluggish UK economy.

Rising Yields

Benchmark 10-year yields have surged to as high as 4.9135%, reflecting an increase of 8 basis points in one day, reaching levels not seen since August 2008. In the wake of reduced expectations around Bank of England rate cuts, increased borrowing in the new government’s Oct. 30 budget, and higher US Treasury yields due to anticipated loose fiscal policies from President-elect Donald Trump, UK bond yields have been climbing since September.

Broader Context

Although rising yields are also observed in major economies like the US, France, and Germany, the UK is currently at the forefront of this upward trend. This increase in yields presents challenges for UK Chancellor Rachel Reeves, as the higher costs of servicing national debt may hinder her ability to meet medium-term borrowing targets, which will be updated on March 26.

Analysts at Goldman Sachs indicate that the rise in yields thus far leaves the UK government with marginally negative fiscal headroom against its deficit rule. Any further increases in yields, combined with a potential growth downgrade from the Office for Budget Responsibility (OBR) on March 26, could worsen fiscal metrics, increasing pressure for corrective action.

Economic Impact

Additionally, these higher yields could slow growth through challenges in household remortgaging and reduced investments. Goldman Sachs predicts that the rise in gilt yields will negatively impact UK growth, forecasting a mere 0.9% real GDP growth in 2025, sharply below the consensus of 1.4%, the BoE’s 1.5%, and the OBR’s 2%.

Despite concerning forecasts about growth, the necessity for rate cuts by the Bank of England may be amplified due to long-term interest rates. As Goldman Sachs notes, a 25 basis points Bank Rate cut in February remains likely, barring any significant surprises in wage and inflation data. Continued quarterly cuts through the year are expected as economic activity falls short of expectations.