With many of the details having been briefed in advance, there was a muted market reaction to last week’s UK autumn statement, which announced a fiscal tightening worth £55 billion or 2.5% of GDP by financial year 2027/8. As our chart shows, long-term index-linked yields are now well below the levels seen during the Liz Truss administration, when they briefly moved above most estimates of trend growth, putting the public finances on an unstable footing. Perhaps the more important point, however, is that long-term real rates of interest have nevertheless risen materially, by almost 250 basis points since the beginning of the year. This is not a phenomenon that is confined to the UK. The dramatic turnaround in index-linked government yields has gone beyond what can be explained by expectations of conventional monetary tightening. It is also hard to square with textbook models of the fall in global real risk-free rates of interest, which emphasise the role played by an ageing population in raising the demand for assets against a supply that is often assumed to be fixed or falling, putting downward pressure on asset returns. Those models may be wrong, or it may be that even major-economy sovereign yields were never quite as risk-free as the textbooks had imagined. But another explanation relates to QE and the idea of fiscal dominance — central banks announcing a partial reversal of QE signals that the era when monetary policy was set to suit the government’s fiscal needs is over, thanks to rising inflation, so markets are now taking a renewed interest in the fiscal position.
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The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.
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