In Focus: Fixed income  

UK bond yields surge, pound crashes in wake of 'mini budget'

UK bond yields surge, pound crashes in wake of 'mini budget'
Chancellor Kwasi Kwarteng leaves 11 Downing Street to deliver his growth plan to parliament (Source: HM Treasury)

The value of UK Treasuries has fallen sharply after the new chancellor's fiscal statement on Friday, which announced a raft of unfunded tax cuts for businesses and high earners as well as home buyers.

The yield on the 10-year UK government bond surged above 4 per cent on Monday morning as the pound crashed, after investors decided they had little faith in the economic plans of Liz Truss's government.

As of Tuesday (September 27) the 10-year gilt yield stood at 4.1 per cent, having increased by 1.26 percentage points so far in September.

The yield on the two-year gilt, which is sensitive to Bank of England policy, stood at 4.3 per cent, having surged from around 3 per cent since the start of the month.

The Bank of England said on Monday it would make any further decisions on interest rates at its November meeting, rather than hold an emergency interim meeting as anticipated after the pound crashed to an all-time low of $1.035 on Monday morning. It has since rebounded slightly to $1.08.

Meanwhile mortgage lenders have begun to pull deals amid concerns over rising rates. Gilt yields impact swap rates, which lenders’ use to guide their mortgage offers.

The yield on the 10-year gilt had initially risen 0.24 percentage points to 3.7 per cent by Friday lunchtime, following the fiscal statement, while that on the 2-year reached 3.9 per cent, up almost 0.4 percentage points on the day.

But comments by chancellor Kwasi Kwarteng on the weekend, suggesting further tax cuts down the line, wiped further value off the bonds as buyers expected more interest rate rises amid increased borrowing by the government.

All the while, the Bank of England last week (September 22) confirmed it would start its quantitative tightening programme in October, actively selling back bonds and effectively withdrawing from the buyer pool. This typically has the effect of raising yields and lowering bond prices.

Evangelia Gkeka, senior manager research analyst, fixed income, at Morningstar, said: "Gilts were already under pressure and recorded significant negative returns year-to-date driven by global inflationary pressures and the start of the interest rate hiking cycle.

"The announced budget that included significant tax cuts and spending plans, in combination with the previously announced support measures on the energy side have the aim to support the economy in the short-term and help preventing a recession.

"However, the market reacted negatively on the announcement of the budget plan and we saw substantial moves with the Sterling weakening and gilts yields spiking.

"It seems that the market has the view that support measures will result in more government borrowing when borrowing costs are increasing and will further increase the debt to GDP and budget deficit, while also creating even higher inflation and the need to increase rates to a higher level than what is currently projected, ultimately even potentially creating debt sustainability issues."

Mini budget

The government announced a swathe of tax cuts on Friday morning, including abolishing the 45p higher income tax rate and cutting the basic rate by 1p in the pound from April 2023. It will also cut stamp duty and create low tax options for businesses.