The week ahead: gilt rout isn’t 'Liz Truss 2.0'

The jump in gilt yields, especially long-term ones, and a bit of weakness in the pound at the end of last year have drawn inevitable comparisons to the disastrous Liz Truss ‘mini-budget’. In reality, the similarities are superficial. This time it’s global bond markets driving the sell off, the speed and the scale is much slower, and there is no sign of any issues in financial markets that might amplify the market moves or cause the Bank of England (BoE) to step in.

That said, UK gilts have been hit harder than other countries and, even if it’s not a Truss 2.0 moment, it’s not great for the economic outlook over the next few years.

At face value, the rise in gilts since the budget at the end of October looks pretty damning. The yield on 10-year gilts has risen by almost 0.5 percentage points (ppts), from 4.35% to 4.84%. 30-year gilts have risen by almost 0.6ppts to the highest since 1998. But this has much more to do with a global rise in government bond yields than the UK budget. The yield on 10-year US treasuries has risen by 0.46ppts over the same timeframe. Notably, French government bonds have only risen by 0.3ppts. Why the UK has been hit harder than France, which has a higher debt-GDP ratio, a higher deficit and more political instability is a bit of a mystery, but it is probably because the European Central Bank is far more likely to aggressively cut interest rates and that the UK relies more heavily on international bond markets for financing.

What’s more, the scale and speed of the re-pricing is also quite different from what we saw during the Truss period. Back then, the 30-year gilt yield rose by around 120 basis points (bp) in less than a week. It’s now close to 80bps in over two months. In other words, the move this time has been more orderly.

Finally, there is no sign of the disorder in financial markets that accompanied the Liz Truss budget, especially the forced selling by pension funds that amplified the market moves. 

So, the move up in gilt yields over the past couple of months has much more to do with worries about sticky inflation globally, driven by the potential of tariffs and fiscal stimulus coming out of the US, than it does the UK budget. 

While that should provide some relief, it doesn’t mean we’re off the hook. The recent market moves could have two negative implications for the UK economy. 

First, gilt yields set the baseline for longer-term borrowing, so higher gilt yields mean higher mortgage costs and more expensive loans to private equity and the real economy. This will weigh on economic activity even if the BoE cuts interest rates this year. 

Second, Chancellor Reeves left herself with a wafer-thin headroom of £10bn against her fiscal target after the last budget. The recent move up in gilt yields means she has probably already blown through that buffer. As she has repeatedly emphasised the need for fiscal discipline, she’ll need to get borrowing back below the target by the time the OBR produces its next forecast on 26 March, that means either more taxes or being less generous with some of the spending pledges she announced in the Autumn Budget. Given she has also said there will only be one fiscal event a year, we assume she’ll trim back spending. That might not mean lower spending this year, but jittery financial markets might not take a pledge to cut spending in the far future as particularly credible, meaning reductions are likely to come sooner rather than later. This poses a risk to our relatively optimistic view of economic growth over the next few years, which was in part based on a surge in government spending and investment. 

Overall, if maintained for the whole of this year, the recent rise in interest rates is enough to knock 0.1-0.2 ppts off our forecast for growth, any reduction in government spending would amplify the blow.

The good news is that, even with higher gilt yields, the economy should still grow more quickly this year than in 2024.

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