UK gilt yields are expected to fall over the remainder of the year, analysts and investors have said, a shift that would help restore the £10 billion to £12 billion of fiscal headroom lost to rising borrowing costs since February before the budget on 28 October.
The forecasts come weeks after Andy Burnham’s new government took office and ahead of John Healey’s first budget as chancellor.
Analysts and investors said the UK’s inflation outlook supports the chances of interest rate cuts. Concerns about the credibility of Kevin Warsh, the new chairman of the US Federal Reserve, and a more expansionary fiscal environment in Japan are other factors they said could lead investors to choose gilts over other assets.
Daniel von Ahlen, a strategist at TS Lombard, said bond investors should “double down on gilts” in the coming months, and said UK bond prices would rise relative to peers in Japan, the US and Germany.
Markets are pricing in two Bank of England rate rises over the next year, but Von Ahlen said there was a higher likelihood that borrowing costs would be cut “as the labour market remains in the doldrums”.
The stakes for the Treasury are set out in the arithmetic of the public finances. The rise in gilt yields since February, when the US-Iran war broke out, has removed about £10 billion to £12 billion from the headroom the government holds against its fiscal rules. A 1 percentage point increase in the ten-year gilt yield adds £12 billion to £15 billion to the government’s debt interest bill.
Gilts have been among the worst-performing government bonds this year, with the UK economy the most exposed to the energy price shock caused by the Middle East conflict. But the past three inflation readings have undershot the Bank of England’s estimates, suggesting the spillover from higher oil prices into the rest of the economy has been limited.
That improvement showed up in July, when gilts outperformed their peers. Total monthly returns on UK bonds were flat, compared with a fall of 1.2 per cent for US treasuries and a 0.7 per cent decline for German bonds, according to Deutsche Bank.
Mark Dowding, chief investment officer at RBC Blue Bay Asset Management, who has had a pessimistic view of gilts this year, said he was no more “constructive on the near-term outlook” for UK government debt after the Bank of England’s latest meeting.
“The doveish bias of the monetary policy committee may encourage investors to add exposure [to gilts],” Dowding said.
Analysts at BlackRock, the world’s largest asset manager, said they had a “neutral” position on gilts, compared with underweight, or reduced, exposure to Japanese government debt and long-term US government bonds.
Japanese government bonds have been the worst-performing significant debt class this year, as the world’s third-largest economy prepares to raise interest rates from record lows and a new government maintains expansionary fiscal policy through tax cuts and investment spending. The US intervened last week to support Japan’s weakening currency and warned that the sell-off in Japanese bonds could spill over into US treasuries.
The UK’s borrowing costs could fall further this year as the Bank of England is expected to reduce the pace at which it sells gilts on its balance sheet back to investors. Analysts at Bank of America said the Bank would cut its annual pace of quantitative tightening from £70 billion to £50 billion from September.
