UK bond yields have returned to levels last seen before September’s controversial “mini” budget as investors welcomed Rishi Sunak’s confirmation as the UK’s new prime minister on Tuesday.
Yields on the 30-year gilt — as the nation’s bonds are known — fell to 3.61 per cent, extending its price rise on Monday as markets reacted with relief to Mr Sunak’s emergence as the sole candidate for the Conservative party leadership.
The move means long-term bonds, which were at the centre of a chaotic sell-off last month that prompted emergency intervention from the Bank of England, have recovered the losses triggered by Liz Truss’s package of tax cuts.
Yields on the 30-year bond, which had surged as investors worried about the UK’s hefty borrowing needs, traded at 3.75 per cent before the former prime minister’s fiscal plans were unveiled on September 23.
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Two-year gilts have also recovered their post-budget losses, trading at 3.27 per cent on Tuesday. Ten-year gilt yields remain slightly higher at 3.6 per cent, compared with 3.5 per cent on September 23.
The pound also climbed on Tuesday, rising 1.6 per cent against the dollar to $1.1461, helped by a broader retreat by the US currency.
“On the face of it, this suggests the last month has been a waking nightmare, and we’re back to where we would have been if Rishi Sunak had won the Tory leadership in the first place,” said James Athey, a fixed-income portfolio manager at Abrdn.
Mr Athey said that concerns over UK institutional credibility, sparked by Ms Truss’s decision to announce £45 billion of unfunded tax cuts without consulting the UK budget watchdog, were no longer the market’s focus and investors should return to watching economic data and the Bank of England (BOE) for clues on the next move for gilts.
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Mr Sunak’s confirmation that he will retain chancellor Jeremy Hunt — whose scrapping of most of Ms Truss’s tax cuts helped restore order to the gilt market last week — should help UK government bonds rally further, analysts say.
“The market hope is that Mr Sunak, a former chancellor of the exchequer and architect of tax rises that were subsequently reversed by the ill-fated mini-budget, will err on the side of fiscal caution,” said Antoine Bouvet, a rates strategist at ING.
The fall in yields since their peak in late September would save the UK government roughly £1.5 billion in interest costs next year based on current issuance plans, according to Mr Bouvet.
Gilts have also benefited from an increasingly bleak outlook for the UK economy, which has led investors to question how far the BOE will be able to raise interest rates as it battles high inflation.
Traders now expect UK interest rates to peak at 5 per cent next summer, up from the current level of 2.25 per cent. During the recent chaos in the gilt market, which sparked a liquidity crisis at UK pension funds, markets had bet that rates would have to rise above 6 per cent to stabilise the pound and offset the inflationary effect of Ms Truss’s borrowing plans.
A closely watched survey on Monday showed that UK private sector activity contracted at its fastest pace in almost two years in October, suggesting the country had already entered a recession.
“This rally tells you that people are back to looking at the economic outlook, and it’s god-awful,” Mr Athey said.
— Copyright The Financial Times Limited 2022
