Borrowing costs spike as Middle East conflict rages
The cost of UK government borrowing spiked on Tuesday morning, while the pound plummeted as markets continued to digest the impacts of the intensifying conflict in the Middle East.
The yield on the 10-year Gilt jumped 0.15 percentage points to 4.46 per cent while 2-year Gilt yields, which closely track interest rate expectations, spiked 0.16 percentage points to 3.81 per cent.
Gilt yields are heavily influenced by market expectations for the future path of interest rates.
Investors think that the Bank of England may be forced to delay cutting rates due to the spike in energy prices following Iranian strikes on crucial infrastructure across the Gulf.
The price of UK wholesale gas prices – which reflect the costs energy suppliers pay to producers for natural gas before selling to households and businesses – has rocketed by 93 per cent this week alone.
“The main economic consequence of higher energy prices would be to boost inflation,” economists at Investec said in a research note.
“In the UK, illustratively, the current level of the oil price would, if maintained, add about 0.2 percentage points to headline inflation via higher petrol prices; and a sustained 40 per cent shift up in natural gas price futures would boost this by a further 0.7 percentage points or so, via higher household utility bills.”
Markets now put the odds of a March rate cut at a little under 50 per cent, down from nearer 86 per cent when the conflict started.
The spike in borrowing costs also comes just a few hours ahead of the Spring Statement, in which the Office for Budget Responsibility (OBR) will publish its latest forecasts.
Analysts said that the spike in borrowing costs could dampen the mood for the Chancellor, as she tries to convince markets that she has created “a stronger and more secure economy“.
“The worry is that the rise in Gilt yields erodes headroom as inflation risks push back the Bank of England’s rate-cutting schedule,” said Neil Wilson, investor strategist at Saxo UK.
Sterling also suffered from selling pressure on Tuesday as investors dumped the currency in favour of the dollar. The pound was trading 0.76 per cent lower at $1.33, its lowest level since early December.
“The dollar was stronger across the board yesterday as investors reacted to the surge in energy prices,” said Chris Turner, an FX analyst at ING said.
Currencies of many energy-importing countries were trading lower, including the euro and many emerging market currencies, while energy-exporters saw some support.
“For FX markets, this continues to look like a tale of the haves and the have-nots when it comes to energy independence,” Turner said.
“The dollar looks like the best currency to take advantage of this energy shock, but other big natural gas exporters like Australia and Norway are seeing their currencies outperform too.”