UK Gilt Yields Ease but Remain Close to Two-Month Highs

UK 10-year gilt yields fell back below 5%, though they remained near two-month highs, tracking a decline in US Treasury yields after softer-than-expected US inflation data reduced expectations for Federal Reserve rate hikes this year. However, Middle East tensions raised concerns that rising energy prices could reignite inflation and push interest rates higher, leading markets to increase bets on Bank of England rate hikes. Investors now nearly fully expect two increases in 2026, with a September hike fully priced in. Attention also shifted to UK politics, as Andy Burnham prepares to replace Keir Starmer as prime minister on July 20. The focus is on his choice for finance minister, with Ed Miliband, seen as fiscally expansive, emerging as the favorite. This prospect has unsettled gilt investors, who are already wary of Britain’s fiscal fragility.

UK 10-year gilt yields climbed above 5%, reaching their highest level since May 21, as the Middle East conflict stoked fears that rising energy prices could drive inflation and interest rates higher. Two-year gilt yields also rose above 4.4%, their highest in nearly two months, after gaining nearly 13 basis points on Monday. The US military continued strikes against Iran after President Donald Trump reinstated a blockade on Iranian shipping and proposed a 20% fee to guard the Strait of Hormuz, heightening uncertainty over energy flows. Markets responded by pricing in further Bank of England rate hikes, nearly fully expecting two increases in 2026, with a September hike now fully priced in. In the US, Fed Governor Christopher Waller warned that the central bank may need to raise rates "in the near term" if inflation remains above the 2% target. Investors now await remarks from Federal Reserve Chair Kevin Warsh and US inflation data later today.

UK 10-year gilt yields rose to 4.91% as oil prices surged after another round of US strikes on Iran, with disputes over the Strait of Hormuz’s status intensifying. The US Central Command reported targeting dozens of sites to weaken Iran’s ability to threaten regional shipping, while Iran announced the strait would remain closed "until further notice." The uncertainty heightened inflation concerns, leading investors to bet on further Bank of England rate hikes, with markets pricing in at least one increase this year and a strong chance of a second. On the political front, Andy Burnham is set to become the new Labour party leader when the leadership contest ends on Friday, July 17, and is expected to be officially appointed as prime minister on Monday, July 20.