“I think there has been more reaction as the impact from yesterday is digested. For example, the Institute for Fiscal Studies now believes Reeves’ £25bn national insurance revenue boost will in practice be far less (c.£16bn) because of the impact of lower wage growth, which means more gilt issuance.
"The OBR put an estimate on the structural impact on gilt yields from increased issuance, which they estimated would be 0.25 per cent higher. The forecasts for the BoE base rate cuts have reduced due to the inflationary impact of yesterday’s package.”
One of the factors impacting the supply/demand dynamics for all developed economies right now is quantitative tightening.
This is the process of central banks reducing the holdings of government bonds they own by selling them on the open market, those sales are happening at the same time as the government is selling new bonds into the market, putting upward pressure on yields.
The BoE is presently selling bonds at the rate of about £100bn a year.
Rates of change
David Roberts, head of fixed income at Nedgroup Investments, responded to the gyrations in the gilt market on Budget day and the aftermath by selling his entire holding of UK government bonds.
He says: “The UK Budget has increased the government's borrowing requirement. At the same time growth forecasts were revised downward, inflation up, leading the market to conclude the BoE would cut interest rates less than forecast.
"Gilt market volatility was extreme, rallying ahead and during chancellor Reeves' speech before falling sharply. Not quite Truss-esque but certainly reminiscent of those days. We took advantage of the initial rally and sold our entire gilt exposure, buying back when the market then sold off. UK volatility reinforced our view that it is often preferable to adopt a global rather than domestic strategy.”
Gerard Lyons, chief economic strategist at Netwealth, says that while he still expects the BoE to cut interest rates, an impact of the increased spending announced in the Budget could mean inflation stays slightly higher for longer, limiting the ability of the BoE to cut interest rates.
The price of gilts prior to the Budget reflected the markets view that inflation would reach a certain level, and interest rate cuts happen at a particular frequency and scale.
Lyons' view is that the Budget, particularly as it increases government spending in the coming years, is likely to mean rates will not be cut to the extent the market previously expected, which is behind the volatility in gilts, as investors try to reprice the asset class to reflect the changed interest rate outlook.
