Gilt Yields Ease as Traders Scale Back Rate Hike Bets

The UK 10-year gilt yield fell below 5.4% as investors pared back expectations for Bank of England rate hikes. Chief Economist Huw Pill, one of the bank’s most hawkish policymakers, expressed skepticism over market pricing of four rate increases over the coming year. While arguing that the BoE should have acted sooner to address the energy shock triggered by the Iran war, he said stronger evidence was needed to justify a larger rate increase. Governor Andrew Bailey, however, warned that a rate hike 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, while expectations for four 25-basis-point hikes by June 2027 have eased slightly. Meanwhile, the IMF has warned the UK government needs to explain how it will cover the cost of increased defense spending, as the country faces an additional annual bill of £11 billion to raise military spending to 3% of GDP by 2030.

The UK 10-year gilt yield eased to 5.4%, tracking US Treasury yields lower following a US market holiday, while oil prices ended a three-session rally. Investors also welcomed the IMF’s upward revision to its UK growth forecast, with GDP now expected to expand by 1.3% this year, up from the 1.0% projected in July. Attention is now turning to Chancellor John Healey’s upcoming Budget later this month, after the Institute for Fiscal Studies warned that the government must find £35 billion to meet its spending ambitions, fueling speculation over potential tax increases. On monetary policy, hawkish BoE policymaker Megan Greene argued that stronger-than-expected growth and a resilient labor market suggest interest rates should be higher than the current 3.75% to bring inflation under control. Markets are pricing in four rate hikes over the next 12 months, although many analysts consider this outlook excessive, given that several policymakers already view the current rate as above neutral.

The UK 10-year gilt yield climbed to 5.45%, approaching a recent 19-year high, as rising oil prices and renewed inflation concerns weighed on sentiment, while investors increasingly focused on Chancellor John Healey’s upcoming Budget. Brent crude rose to $107 a barrel following a deadly attack on Riyadh’s airport in Saudi Arabia, while Ukraine reported continued Russian strikes on its energy infrastructure. Meanwhile, the Institute for Fiscal Studies has warned that Healey must find £35 billion to meet the government’s spending ambitions, fueling speculation over potential tax rises. Investors are now awaiting Wednesday’s US inflation data and this week’s IMF-World Bank meetings, where Bank of England officials are expected to offer further insight into the inflation outlook and interest-rate trajectory. Markets are pricing in four BoE rate hikes over the next 12 months, but this may prove excessive, as several policymakers already consider the current 3.75% rate to be above neutral.