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Volatile UK Gilt Market Pressures BoE To Turn Hawkish

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It’s been a rollercoaster month for the UK’s financial market following the bungled mini-budget on 23 September that sent equities spiralling, the pound plummeting to an all-time low against the dollar and bond yields soaring higher.

In the first few days following Kwasi Kwarteng’s announcement of the mini-budget, Investing.com data showed that 30-year gilt yields rose by roughly 120bps. The bond sell-off forced the Bank of England to intervene and start buying long-term gilts over the next fortnight in order to calm jitters and stabilise pension funds.

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This move led to gilts climbing down, but by 10 October they were heading back to near their September highs – the 30-year yield hit 4.7% versus its 5% high and the 20-year yield reached 4.8% versus 5%, according to Investing.com.

Mixed messages from the Bank of England over whether it would continue to provide support to pension funds beyond 14 October led to uncertainty and panic. The market was concerned that it was too soon for the central bank to pull its support.

Some confidence was restored last week when the new chancellor Jeremy Hunt decided to rip up Kwarteng’s mini-budget and u-turned on Kwarteng’s tax cuts. But bond yields crept slightly higher once again after Liz Truss announced her resignation on Friday 21 October afternoon.

Despite the current volatility, “the fall in gilt yields is still helpful in that it now brings the UK back into the pack when it comes to rising rates, as well as lowering the amount of interest that would have been payable on UK borrowing,” says CMC Markets’ chief analyst Michael Hewson (click here to learn more about CMC Markets).

Following the release of the mini-budget, the market has priced in an aggressive interest hike ahead of the 3 November Bank of England meeting. However, the central bank could now take a slightly gentler approach.

Falling yields don’t “shelter the UK economy from further rate increases”, however, Hewson points out. The Federal Reserve could decide on two more 75bps rises before year-end and this “would increase pressure on the Bank of England to act in a much more hawkish fashion,” Hewson adds.

UK's New PM Could Whipsaw Yields Again

The turmoil in the bond market over the past month has sent some investors fleeing to more conventional standard savings accounts. Investing.com data noted the yield on 30-year bonds was roughly 1.2% at the start of the year, but the volatility means they’re currently not the safe haven asset that they’ve traditionally been considered.

The government is slated to deliver its debt-cutting, medium-term fiscal plan on 31 October, days after announcing Rishi Sunak as the new prime minister on Monday 24 October. Putting the economy in the hands of Sunak, with his background in finance, may help gilts to rally and send yields lower.

Sunak will become the British Prime Minister after other candidates quit the race on Monday 24 October. “Markets are hoping that the coronation of Rishi Sunak as the next UK Prime Minister will help draw a line under the events of recent days,” says Hewson.

In fact, gilts jumped in price upon the announcement on Monday afternoon, although there is still much work to be done to stabilise the financial markets.

Until it becomes clear how the new prime minister intends to steady the ship through this storm, there could be further volatility in the bond market.

As ratings agency Moody’s explained in its reasoning for downgrading the UK’s economic outlook from stable to negative last week: “The recent rise in government bond yields is in part a reflection of wider market concerns around the credibility of UK policymaking”.

Hewson adds that: “The fall in UK gilt yields does suggest one thing and that is we will probably see a budget delivered next week and all the indications are it will be delivered by Jeremy Hunt, the existing Chancellor of the Exchequer.”

For those who want to speculate on whether their values will fall and yields will rise amid this political uncertainty, spread betting can be an effective way to trade on bonds without holding them outright. Learn more about spread betting.