Analysis: UK bonds and sterling at center of storm as fiscal shock hammers confidence

  • Investors reeling from Kwarteng’s borrowing plan
  • UK 5-year bonds suffer biggest daily decline in 31 years
  • Sterling drops 3% to 37-year low below $1.09

LONDON, Sept 23 (Reuters) – Britain’s bond market suffered its biggest daily decline in decades on Friday and is set to slump further as investors stifled by the prospect of hundreds of billions of pounds more borrowing to fund the cuts taxes and energy bills.

Finance Minister Kwasi Kwarteng’s plans will require an additional £72bn ($79bn) of public borrowing over the next six months alone, and – of particular concern to investors – cement permanent tax cuts at a cost of £45 billion a year.

The market response was brutal, not only among bond investors, but also for the British pound, which fell to a new 37-year low against the US dollar below $ 1.09, down more 3% over the day.

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The FTSE-100 blue chip stock index closed down 2%, its lowest close since mid-June.

“Today’s budget announcement is a huge unfunded bet for the UK economy,” said Ben Nabarro and Jamie Searle, economist and fixed income strategist at US bank Citi, a leading government debt trader. British.

Five-year gilt yields, which move in the opposite direction to prices, rose a massive 50 basis points on the day to a 14-year high of 4.06% – an increase of more than 15 times their movement normal daily and the largest daily increase since at least 1991.

Yields on ten-year gilts jumped 33 basis points to 3.83%, their highest level since April 2011 and a yield 1.78 percentage points higher than that offered for equivalent German government bonds, the largest performance bonus since independence from the Bank of England in 1997.

Higher bond yields may seem abstract to people outside financial markets, but they directly increase the cost of new government borrowing and indirectly drive up interest rates for households and businesses.

For Kwarteng and new Prime Minister Liz Truss, the tax cuts are key to a deregulation agenda that aims to boost Britain’s long-term growth by a full percentage point to 2.5%.

But for bond investors, they bring the prospect of more persistent inflationary pressures – at a time when inflation is already near a 40-year high – as well as tighter policy from the Bank of England (BoE ). Markets see BoE rates above 5% by August next year, a staggering 2.25% increase now and just 0.1% in 2021.

Government borrowing is expected to hit £218bn this financial year and £229bn in 2023/24, Citi predicted, and it expects benchmark 10-year UK government bond yields to rise. at 4.25%.

NatWest, another primary trader, sees 10-year yields rise even further to 4.5%.

“The government has announced a pandemic-wide fiscal stimulus … but without the offsetting monetary stimulus, in the form of QE, to absorb any additional emissions,” wrote NatWest economist Ross Walker and the rate strategist Imogen Bachra.

Adding to the pressure, the BoE confirmed on Thursday that it plans to cut its own £838 billion worth of gilts by £80 billion over the coming year.


Friday’s plunge in bond and sterling prices did not come out of nowhere.

Sterling and gilt prices have been under pressure all year – as has euro and eurozone debt – due to rapidly rising inflation and tighter monetary policy. US Federal Reserve, which was less economically affected by Russia’s invasion of Ukraine.

Currencies such as the Japanese yen and Swedish krona have fallen more against the dollar so far this year than the 19% fall in the pound.

However, Friday’s statement crystallized unease about Britain’s vulnerability to inflation and the post-Brexit policy stance, which had been reinforced after Truss promised to overturn “Treasury orthodoxy to stimulate growth.

Mike Riddell, senior bond portfolio manager at Allianz Global Investors, said it was a worrying sign of rising yields and expected BoE rate hikes had failed to boost sterling.

“It’s a strong indication that investors at home and abroad are losing faith in the UK’s inflation-fighting credibility,” he said.

Citi said a crisis in confidence could send the pound plummeting to parity with the dollar, while JP Morgan said the outsized scale of Friday’s market moves “reflects a broader loss of investor confidence in the market.” government’s approach.

Deutsche Bank said the BoE needed to make an emergency rate hike as early as next week to restore credibility. Read more

Some commentators have compared the performance of sterling and gilts to the type of movement seen more often in emerging markets.

“I don’t think the UK is there yet, but it’s a direction of travel,” said Mike Kelly, head of multi-asset at PineBridge Investments in New York. “A fiscal push in a depleted liquidity environment explains the weakness of the pound sterling.”

BoE policymaker Jonathan Haskel said late Thursday that he was not worried about sterling’s weakness and stressed the importance of respected political institutions in maintaining investor confidence. Read more

Business lobby groups have been more supportive of the government’s measures than financial markets, welcoming the prospect of planning reforms and tax cuts.

Yet these business-friendly measures failed to shore up UK equities. The domestically focused FTSE 250 stock index fell to its lowest level since November 2020.

($1 = 0.9147 pounds)

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Reporting by David Milliken Additional reporting by Harry Robertson Editing by Mark Potter

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