U.K. gilt yields surge, with 10-year topping 4%, as investors bet on aggressive Bank of England action to tame tax cuts

By Steve Goldstein

U.K. bond yields surged on Monday for a second day, as investors bet the Bank of England will have to take aggressive action to offset the impact of surprisingly large tax cuts.

The yield on the 2-year gilt /zigman2/quotes/211347169/realtime BX:TMBMKGB-02Y -1.79% surged 57 basis points to 4.48%, after a 41 basis point surge on Friday, and the yield on the 10-year gilt /zigman2/quotes/211347177/realtime BX:TMBMKGB-10Y -1.25% rose 29 basis points to 4.11%, after a 33 basis point increase on Friday.

The spread to the German 10 year /zigman2/quotes/211347112/realtime BX:TMBMKDE-10Y +0.08% was the highest since 1992.

Yields move in the opposite direction to prices.

Gyrations continued after Friday’s announcement of £45 billion in tax cuts and £60 billion in energy support over the next six months.

Economists at Bank of America took their terminal Bank of England rate forecast to 5.25%, up a full percentage point, in the wake of the mini-budget tax-cut frenzy announced by Chancellor Kwasi Kwarteng. They’re now expecting 75 basis point hikes in November, December and February, with a risk of a 100 basis point hike in November.

“U.K. asset prices reacted to the fiscal package in a way more akin to an emerging market, with sterling and gilts selling off,” said economists led by Robert Wood, chief U.K. economist at BofA. “In our view, this reflects increased debt sustainability and fiscal dominance risks. Both are far from a base case: this or a future government could return the finances to a sustainable path; we expect the BoE to demonstrate its independence. But it would be brave in our view to argue that neither risk had risen.”

Some were speculating the BoE might have to act before November’s scheduled meeting. “The OIS market is now pricing a hike in Bank Rate of 100bps at the BoE’s November policy meeting, and we certainly agree that looks a sensible bet. Of course, given the inflationary impact of the weak pound, should sterling take further steps lower in a disorderly manner, the [Bank of England Monetary Policy Committee] might well have to hike before than meeting arrives to try to stem the tide,” said Emily Nicol, an economist at Daiwa Capital Markets.

The pound /zigman2/quotes/210561263/realtime/sampled GBPUSD -0.4229% fell to a record low near $1.03 in Asian hours on Monday before recovering to the $1.07 level.

Kwarteng suggested on Sunday that even more tax cuts were coming. “I want to see, over the next year, people retain more of their income,” he said.

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