UK Gilt Yields Surge on Political Risks and US-Iran Standoff

The UK 10-year gilt yield climbed to 5.38%, recovering from a three-week low recorded on October 15, as investors assessed stronger economic data and the outlook for interest rates and public finances. UK GDP unexpectedly expanded by 0.1% in August, avoiding forecasts of a contraction. The resilience has strengthened expectations that the Bank of England could raise rates, with markets largely anticipating a 25-basis-point increase on November 5, although those bets have eased slightly. Governor Andrew Bailey said there was limited evidence that higher energy costs were feeding into broader prices and wages, but cautioned that it remained too early to assess the risk of persistent inflation. Other policymakers, including Megan Greene and Huw Pill, have urged earlier action to prevent such second-round effects. Meanwhile, Chancellor John Healey is preparing his October 29 budget, promising measures to provide some economic relief while maintaining efforts to reduce the deficit.

The UK 10-year gilt yield slipped below 5.35%, the lowest in three weeks, due to renewed appetite for government bonds amid a global equity selloff. At the same time, the latest data showed GDP expanded by 0.1% in August, following a 0.4% increase in July, avoiding forecasts of a contraction. Output also grew 0.7% over the three months to August, marking a fourth consecutive month in which growth exceeded expectations. The resilience of the economy, despite elevated energy costs and borrowing expenses, has drawn attention from Bank of England policymakers and could strengthen the argument for another interest-rate increase next month to contain inflation risks linked to the Iran war. The figures come ahead of Chancellor John Healey’s first budget on October 28. Although stronger activity could prompt an upgrade to the UK’s growth outlook, rising gilt yields and pressure to support households leave the government with limited fiscal flexibility.

The UK 10-year gilt yield rose to 5.46%, nearing its highest level since July 2007, tracking higher US Treasury yields after stronger-than-expected US inflation boosted expectations of a Federal Reserve rate hike this month. Meanwhile, BoE Chief Economist Huw Pill expressed skepticism about market expectations for four rate increases over the coming year, arguing that stronger evidence was needed to justify a larger hike despite the need to address the energy shock triggered by the Iran war. Governor Andrew Bailey, however, warned that a rate increase would become increasingly difficult to avoid if the energy shock persists. Markets see a near-100% chance of a BoE rate hike in November, its first in over three years, though expectations for four increases by June 2027 have eased slightly. Separately, the IMF urged the UK government to clarify how it will fund higher defense spending, with an additional £11 billion annually needed to raise military expenditure to 3% of GDP by 2030.