Gilt 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.
The 30-year gilt yield fell to 3.61 per cent, extending Monday’s price rise as markets reacted with relief to 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 the package of tax cuts announced by former prime minister Liz Truss.
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 Truss’s fiscal plans were unveiled on September 23.
Two-year gilts have also recovered their post-Budget losses, trading at 3.27 per cent on Tuesday. Ten-year gilt yields also fell sharply, aided by a global bond rally, but they remain slightly higher at 3.60 per cent than their level before the Budget of 3.50 per cent.
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.
Athey said that concerns over UK institutional credibility, sparked by Truss’s decision to announce £45bn 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 Band of England for clues on the next move for gilts.
Sunak’s confirmation that he will retain chancellor Jeremy Hunt — whose scrapping of most of 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 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 £1.5bn in interest costs next year based on current issuance plans, according to 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 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,” Athey said.
