Gilt yields drop as Reeves crosses fingers to reap benefits
Gilt yields have fallen as investors breathed a sign of relief after inflation came in below economist expectations, with top analysts claiming an interest rate cut this year is “very much in play” while adding that Rachel Reeves could be in luck.
Gilts, the name for UK government bonds, have regained momentum in the UK after the Office for National Statistics (ONS) said inflation in the year to September was 3.8 per cent.
Economists polled by Bloomberg and the Bank of England had forecast inflation to hit four per cent.
Two-year gilt yields, which are more heavily influenced by inflation data given they track the Bank rate more closely, fell to their lowest level since August 2024. The two-year gilt yield was 3.76 per cent at around 10am on Monday.
The yield on 10-year gilts also dropped to its lowest level seen this year at 4.4 per cent.
After hitting their highest level this century, 30-year gilt yields have also been on a downward trend in the last month. They have fallen from 5.5 per cent to around 5.2 per cent amid clearer suggestions from Rachel Reeves that she was considering making tax hikes and spending cuts to restore her headroom and keep a lid on long-term inflation.
Bond markets are also likely to have been reassured by indications that the Chancellor was looking to build a larger fiscal buffer to “absorb shocks” and prevent another repeat of seeing a shortfall in public finances at future Budgets.
“The decline in yields is down to a confluence of factors including concerns about the growth outlook, today’s lower CPI print, and hopes that Chancellor Rachel Reeves will build a larger fiscal headroom in her budget,” said Kathleen Brooks, research director at the trading platform XTB.
“While tax rises are not good for growth, a mix of tax increases and substantial spending cuts could keep yields subdued.”
Reeves expected to lobby OBR on forecast windows
Falling yields, which move inversely to prices, lessen the blow of debt servicing costs faced by the government. Debt interest payments to the government’s lenders are already forecast to be double expenditure on defence in the current financial year.
Lower inflation than expected prompted leading City analysts to speculate whether Bank officials could choose to lower interest rates this year.
Deutsche Bank economist Sanjay Raja said: “With two additional CPI prints to watch, and two further labour market reports to come before the December meeting, we think there will be enough ammunition for the Monetary Policy Committee to ease rates further.
“With Chancellor Reeves laying the groundwork for lowering the cost of living in the upcoming Budget, we continue to think that a December rate cut is very much in play.”
The fluctuations in bond markets can materially affect official forecasts set by the Office for Budget Responsibility (OBR), which determines the size of the fiscal hole at the Budget.
It is unclear whether the latest falls in bond yields will have been captured by the OBR in its forecasting window.
OBR chiefs based economic measures on financial market data captured over a 10-working day period a month before the Spring Statement.
An upswing in gilt markets and more dovish interest rate expectations can help prevent billions of pounds being knocked off Rachel Reeves’ small headroom.
Panmure Liberum’s Simon French said the timing of the fall in gilt yields could either be “delicious” or “annoying” for the Chancellor.
“Expect representations from the Chancellor’s office to get the OBR to move their calculation period to the right to capture some of this move,” he added.