The UK 10-year gilt yield hitting its highest level since the financial crisis shows that “the bond market has taken fright from the growing sense of inflationary pressures in the air”.
Laith Khalaf, head of investment analysis at AJ Bell, said with yields rising on both sides of the Atlantic, this suggested the new year had brought with it a focus on the incoming US president -Donald Trump, and the potential for his trade and immigration policies to be inflationary, which has implications for both economies.
Additionally, bond investors might also be worried about the level of government debt already on the books on both sides of the pond.
Khalaf said: “It’s somewhat odd that bond yields have risen to new highs so long after interest rates have peaked, which suggests markets were complacent about inflation and overly confident that the Bank of England would cut rates sharply.
“Rachel Reeves appears to be one potential culprit for rising bond yields, which is probably wide of the mark. Reeves’ maiden Budget was marginally inflationary, and did increase overall government borrowing, but since the beginning of October the US and UK 10-year bond yields have tracked upwards almost hand in hand.
“Those who think the current bout of bond market jitters is down to policies announced in the Budget need to explain why there has been such correlation in the upward march of bond yields both here and in the US.”
Susannah Streeter, head of money and markets at Hargreaves Lansdown, said uncertainty in the bond markets over the inflationary impact of Trump’s tariff plans, had led to expectations that interest rates would have to stay higher for longer, causing nervousness among investors.
Streeter added: “Already there was wariness surrounding the level of UK debt and the gilt markets are now in the eye of the storm.
“In the UK, there is also particular concern brewing about stagflation taking hold, given that inflation has been creeping up and pay growth is still hot, while the economy has been stagnating.
“There are concerns this may limit the interest rate reductions by the Bank of England this year. It’s unclear to what extent the UK government’s investment in infrastructure will provide a boost to growth over the longer term. It seems appetite to buy long-term dated UK government debt has fallen amid the increased uncertainty gripping global bond markets.”
While in time the bond market could calm down Khalaf said this would depend on whether there’s global inflation in 2025.
He added: “The US has the benefit of being the world’s reserve currency, which underpins demand for dollar denominated assets such as US Treasury bonds.
“Here in the UK higher yields put pressure on government finances and increase the risk that Reeves will come back with another tax raising Budget.
“A big saving grace is that the new chancellor has limited herself to one Budget per year, and so while we will get an updated set of forecasts from the OBR in March, which will lay bare the state of government finances, we don’t expect Reeves will have to balance the books through tax policies until the back end of the year.
“That gives plenty of time for the bond market to calm down, though that in turn will of course depend on whether global inflation actually rears its head again in 2025.”