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.
The previous government's 1.25 percentage point increase in national insurance for both businesses and taxpayers has also been reversed.
At the same time as effectively cutting its revenue it confirmed its energy support package, including a price guarantee for both households and businesses, would cost £60bn in the first six months alone.
Much of this is unfunded and will need to be financed through issuing gilts.
According to the FT the UK Debt Management Office increased its planned bond sales for the 2022-23 fiscal year by £62.4bn to £193.9bn.
The higher UK government yields are, the more expensive it will be for the government to borrow money.
There are signs that buyers of UK government bonds are becoming even more nervous about the government’s ‘splash the cash’ policies, given the mounting debt pile.Susannah Streeter, Hargreaves LansdownBethany Payne, global bond portfolio manager at Janus Henderson Investors, said on Friday the government's strategy was a "radical economic gamble".
"We had been concerned over the ability of the Bank of England to sustainably sell gilts through the quantitative tightening due to start on October 3, but today we are asking whether quantitive tightening is over before it even began.
"While the extra gilt issuance is close to our consensus before the mini-Budget, what is different is the pace of the issuance which will increase 87 per cent between now and the end of the fiscal year. Issuance is skewed to the front end as well, so shorts have taken a lot of the pain from extra issuance, leading to the curve flattening.
"Meanwhile, it is now likelier that we see bigger rate hikes from the Bank of England – maybe as much as 100bp in November."
Director at Fairview Investing, Ben Yearsley, said the mini “Kwasi budget” was a gamble and a break from the orthodoxy of the Osborne and Hammond years where balancing budgets was the priority.
"If Kwasi Kwarteng’s first acts of chancellor put the UK on the path to sustained higher growth he will rightly be lauded in a similar vein to Lord Lawson, however if it fails it’s probably Lord Lamont he will be compared to," he said.
Sterling fell to $1.11 in the immediate aftermath of the statement, a level not seen for decades, and down 1.28 per cent by Friday lunchtime.
Samuel Mather-Holgate of Swindon-based advisory firm, Mather & Murray Financial, said: "It’s hard to believe economists are talking about pound parity with the dollar. This will severely impact importers, and we buy in a lot more than we export.
"A weak pound has also put pressure on the gilt market, and 2-year borrowing is now at 4 per cent. That’s compared to nearly zero a year ago. This means less money for public spending. This is a big gamble that has to pay off or we're in big trouble."
The UK needs to attract capital to fund this gap and right now it is doing the exact oppositePhilip Dragoumis, Thera Wealth ManagementSusannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, added: "The Truss administration wants to put a rocket under growth, but there is a risk that after a first boost, the policies could crash and burn, particularly if government borrowing costs soar further.
"There are signs that buyers of UK government bonds are becoming even more nervous about the government’s ‘splash the cash’ policies, given the mounting debt pile."
The trade fall-out from the drop in sterling could prove devastating, said Philip Dragoumis, owner of London-based wealth manager, Thera Wealth Management.
"If foreign investors lose confidence in the country, its government and economy, which is happening at scale, sterling could fall much further and the fallout will be devastating…This will keep inflation higher for longer and growth lower.”
He highlighted the UK’s global trade deficit.
“[The UK] needs to attract capital to fund this gap and right now it is doing the exact opposite.”
There could be a positive outcome for DB pension schemes, said Ian Mills, partner at Barnett Waddingham
"The effect of rising gilt yields will be significant – DB pension scheme liabilities will have fallen sharply in just a couple of days, perhaps by as much as 10 per cent for some schemes.
Many schemes will find that their funding positions have improved sharply, particularly those that have not fully hedged their interest rate and inflation risks, he said, adding that for many this will present opportunities to de-risk.
However, DB schemes using liability-driven investments will come under pressure, especially if the rise in yields is sustained, he added.
“The rise in gilt yields will likely cause schemes to have to recapitalise hedges – some will be able to do so from cash reserves but others will find they are forced to sell other assets.
“Some schemes could even be forced to unwind hedges exposing them to the risk of reversals in yields.”
carmen.reichman@ft.com, sally.hickey@ft.com
