Bank of England Governor: The worst period for the UK bond market has passed, stating that interest rate cuts will not be made too quickly or too significantly

The UK Labour Party released a new fiscal budget last week, with a £40 billion tax increase marking the largest scale since 1970, leading to a significant drop in UK bonds. After the Bank of England decided to cut interest rates on Thursday, it stated that the bond sell-off was mainly exacerbated by investors being forced to close short-term bets, suggesting they believe the worst of the decline is over.

At a press conference following the monetary policy decision on Thursday, Bank of England Governor Andrew Bailey told the media that the market had previously bet on a decline in short-term interest rates, but these trading positions were closed after the government announced its fiscal plan. He indicated that this dynamic "may have come to an end."

Last week, UK bonds fell sharply, with the two-year government bond yield rising by more than 25 basis points after Chancellor Rachel Reeves announced plans for tax increases and investments. Traders are concerned that increased government spending in the coming years will fuel inflation, thereby limiting the Bank of England's ability to ease monetary policy.

Bailey said:

"There has been some position closing in the pound market, but if you look at today's market, the situation is quite stable."

Last week, media reports indicated that the sell-off of short-term bonds intensified as investors were forced to exit bets on falling short-term interest rates, and the strategy that originally expected pound bonds to outperform other bond markets was also withdrawn.

Bailey and the Bank of England's Monetary Policy Committee decided on Thursday to lower interest rates by 25 basis points, noting that the sell-off was exacerbated by stop-loss orders being triggered. He added that previously, the market was reluctant to take aggressive positions due to the uncertainty surrounding the results of the U.S. presidential election.

Analysts believe that despite the volatility in the bond market, this price fluctuation is far more orderly than the adverse reaction triggered by former Prime Minister Liz Truss's fiscal plan in 2022, when Truss's policies of tax cuts and increased spending amid high inflation led to a crash in the long-term bond market, and the forced closure of leveraged pension fund strategies further exacerbated market turmoil.

Bank of England Deputy Governor Dave Ramsden stated, "We are monitoring the UK government bond market closely in collaboration with the Debt Management Office, but we are not currently seeing any abnormalities."

Although the interest rate cut was as expected, the Bank of England did not indicate a faster pace of easing, while warning that last week's budget could raise inflation rates by as much as 0.5%. Bailey stated in London:

"We need to ensure that inflation remains close to the target, so we cannot cut rates too quickly or too much. However, if the economy develops as expected, rates may gradually decline from now on."

The Bank of England's voting took place shortly after the U.S. election results became clear, but the meeting minutes hardly mentioned the risks of the U.S.-Europe trade war. Bailey insisted in response to reporters' questions that the Bank of England would not react to potential future U.S. trade policies.

When asked whether U.S. tariffs or the UK budget had a greater impact on the Bank of England, Bailey emphasized the influence of the international environment.

"External shocks are the main factor, but don't get me wrong, we will be paying very close attention to the impact of the UK budget."