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UK borrowing costs have fallen to their lowest in more than a year, as fund managers say reduced anxiety over the public finances and hopes for further Bank of England interest rate cuts are fuelling a recovery in gilts.
Ten-year gilt yields, the benchmark for the UK’s long-term borrowing costs, fell 0.04 percentage points to 4.36 per cent on Wednesday, their lowest level since December 2024. Yields move inversely to prices.
Expectations that falling inflation will allow for deeper BoE rate cuts, as well as an easing of concerns over hefty public borrowing in the wake of UK chancellor Rachel Reeves tax-raising November Budget, have helped gilts outperform a global bond rally in recent weeks, investors say.
“I hear more optimism for gilts,” said Nick Hayes, head of fixed income allocation at Axa Investment Managers.
“Investors think the Bank of England might have more to do than other central banks,” he said, adding that “the worst-case tail risk” of a heavy-borrowing or inflationary Budget had been avoided.
“Reeves has clearly helped reduce the political risk premium by signalling fiscal discipline and predictability, which matters for gilts, but the bigger driver is still a BoE-led rates narrative,” said Fraser Lundie, head of fixed income at Aviva Investors. The government is “riding a powerful macro tide rather than creating it”, he added.
As energy prices fall and wage growth slows, swaps traders are now putting a roughly 80 per cent chance that the BoE will make two quarter-point cuts in its benchmark rate this year, from less than 70 per cent in late December.
Deutsche Bank analysts said this week they expect UK inflation “to take a big step down” this year. Some big investors including Pimco have bet that falling inflation will allow for a rally in gilts.
The rally has helped gilts outperform other big bond markets such as US Treasuries and German Bunds in recent weeks. As a result, the additional interest yield being charged by investors to lend to the UK rather than Germany has fallen below 1.6 percentage points on 10-year debt, its lowest since mid-2024.
The comparable additional rate over US Treasuries, the other global benchmark, is around its lowest since the summer.
The gilt market has suffered bouts of volatility since the 2024 Budget as a combination of a global sell-off and worries over the UK’s public finances — where annual interest payments exceed £100bn — made it a target of investors’ concerns. Ten-year yields hit a 16-year high of 4.93 per cent a year ago.
“The eye has moved on” and is focused on other bond markets for the time being, said Simon French, chief economist at Panmure Liberum, in a reference to the eye of Sauron in The Lord of the Rings.
But there were upcoming catalysts for renewed concerns about the UK position, most notably the May local elections, which carry the potential for leadership challenges to Prime Minister Sir Keir Starmer, he warned.
While Wall Street banks are broadly positive on the gilts outlook this year, JPMorgan analysts are among those expecting the 10-year bond yield to rise this year, in part due to the risk of a leadership challenge after the regional elections.
The UK retains the highest borrowing costs in the G7, and a swing in market expectations on rate cuts could pile pressure back on the government.
While improved inflation numbers are helping the bond market, the rally in government bonds may not last, warned Holger Schmieding at Berenberg bank. “In the long-run these valuations are too optimistic — government deficits are high,” he said. “I don’t see this as a bond market rally that lasts throughout the year — it is short-term relief.”
The declines in government yields will be helpful for the budget “headroom” the chancellor has against her key fiscal rules.
Reeves’ rules require her to fund day-to-day spending with taxes by the end of the parliament and get the public debt burden falling as a share of the economy.
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