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UK bond yields are rising, causing pain for borrowers, including the Treasury and UK Chancellor Rachel Reeves. This rise limits the UK’s fiscal space, while curtailing economic growth. Without the latter, the former gets even tighter. Breaking this cycle is going to be a huge challenge for the UK government and Chancellor. Bond yields are rising for a variety of reasons including international factors, and in particular a recalibration of investors’ expectations about the pace and magnitude of policy tightening by the US Federal Reserve. But inflation in the UK is proving to be stickier than expected and recent wage data highlight this problem: annual growth in private sector pay topped six per cent year-on-year in October. While this above-inflation pay growth is good for households, it keeps upward pressure on inflation, hampering the Bank of England’s ability to cut interest rates further, keeping mortgage rates elevated and squeezing the public finances. We think that the Bank of England will cut the Bank Rate by 25 basis points when it meets in February, but this is likely to be the one and only cut this year. Investors seem to be warming to this view. In our recent Global Outlook, Winter 2024: the new path for interest rates we also warned that with QE seemingly off the table, investors would start to worry about fiscal deficits again. That appears to be happening too.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
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