The path of the Bank of England's interest rates is in doubt, and the 30-year UK government bond yield has reached a 26-year high
The uncertainty surrounding the UK economic outlook has intensified, with the 30-year government bond yield reaching a 26-year high. The reasons behind this include: first, the UK government's borrowing this year has exceeded official expectations, which may lead to an increase in UK government bond supply next year, bringing additional risks to the market. Second, there are internal disagreements within the Bank of England regarding interest rate cuts, making it difficult for the market to accurately predict future interest rate trends. Third, the coexistence of inflationary pressures and weak economic growth has increased the difficulty of policy forecasting
Investor concerns about the UK economic outlook have intensified, with UK long-term bond yields rising to a 26-year high.
On December 20th, Friday Eastern Time, the yield on 30-year UK bonds rose for the seventh consecutive trading day, reaching as high as 5.16%, marking the highest level in 26 years.
In just one week, market bets on the number of interest rate cuts by the Bank of England next year have fluctuated multiple times. The market shifted from betting on four rate cuts by the Bank of England next year to betting on fewer than two cuts, and then to betting on three cuts:
On Monday, the market bet on four rate cuts by the Bank of England next year, totaling over 70 basis points.
On Wednesday, driven by rising fuel prices, UK inflation reached an eight-month high, with November CPI increasing by 2.6% year-on-year, exceeding the Bank's 2% target, exacerbating concerns of stagflation with high inflation and low growth, while London rent increases also hit record levels. The UK faces domestic and international inflation risks, leading the market to reduce rate cut bets, expecting the Bank of England to maintain the interest rate at 4.75% this Thursday, with a cautious forecast of a 49 basis point cut next year. Morgan Stanley predicts that the Bank of England will not start cutting rates until February 2025.
On Thursday, the Bank of England did not cut rates as expected, with inflation likely to continue rising in the short term, but there were significant internal divisions, with three officials calling for a 25 basis point cut, and one-third of the committee voting in favor of a cut, exceeding market expectations. Bank of England Governor Andrew Bailey stated that due to "the high uncertainty of the economy," he "cannot commit to when or how much the rate will be cut." This division and uncertainty further exacerbated market volatility. Traders increased bets on rate cuts, expecting the Bank of England to cut rates three times next year for a total of 61 basis points, higher than the previous expectation of less than 50 basis points.
The fundamental reasons behind market volatility are, first, the unclear outlook for the UK economy, with inflationary pressures coexisting with weak economic growth, increasing the difficulty of policy forecasting. Second, there are divisions within the Bank of England regarding rate cuts, making it difficult for the market to accurately predict future interest rate trends. Third, this year's UK government borrowing may exceed official forecasts, increasing the risk that the government may need further financing early next year, with the potential increase in UK government bond supply becoming a new adverse factor.
Ed Hutchings, head of rates at Aviva Investors, pointed out that 2025 will be a key year for issuance and yield adjustments in the UK government bond market.
Complex Economic Situation for the Bank of England, Increasing Internal Divisions
The UK economy currently presents a mixed picture. The latest business survey from the Bank of England shows a weak labor market, but wage growth has exceeded expectations. This contradictory economic situation, combined with the fiscal stimulus plan announced in October and the global spillover effects from US policies, has made decision-making for the Bank of England more challenging.
Investor concerns about the UK economic outlook are reflected in the Bloomberg index, which shows that a typical UK government bond portfolio has fallen over 4% this year. In contrast, Eurozone government bonds have returned 2% during the same period, while the benchmark index for US government bonds has remained flat. Matthew Ryan, head of market strategy at Ebury, stated:
“Bank of England officials seem to have greater divisions on the future interest rate path than ever before, reflecting the complex outlook for the UK economy, where weak consumer demand is offset by inflation impacts from the autumn budget and Trump’s tariff proposals.” Despite facing many uncertainties, there are also opportunities. If inflationary pressures in the UK ease by 2025, as many economists expect, the Bank of England may cut interest rates more aggressively, leading to a rebound in the bond market.
Guy Stear, Head of Developed Markets Strategy at Amundi Investment Research, believes:
"The three members currently voting for a rate cut may be correct, as the risk is that the six members voting to maintain rates are too focused on recent higher-than-expected inflation data and not giving enough weight to the weak growth data. We believe the Bank of England may cut rates up to five times next year."
However, UK government bond bulls have been disappointed this year. At the beginning of 2024, the market expected the Bank of England to cut rates by about 150 basis points over the year. In reality, the Bank of England has only cut rates by 50 basis points, less than the Federal Reserve and the European Central Bank.
Susannah Streeter, Head of Currency and Markets at Hargreaves Lansdown, stated:
"We are still on a rate-cutting path, but the harsh economic environment means we must slow our pace."