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This week, investors raised the premium on UK government borrowing costs over the US to the highest level in almost a year. They are betting that a challenging inflation outlook and an economic recovery will keep UK interest rates higher for longer. The yield on 10-year gilts rose to over 4 per cent, causing the gap between UK and US borrowing costs to reach 0.18 percentage points, the highest since September last year.
The increase in UK borrowing costs is partially due to concerns about persistent domestic-services inflation and a strong economy keeping interest rates elevated. Additionally, UK government debt prices have fallen behind their European counterparts as investors expect softer inflation data in the eurozone to lead to multiple rate cuts by the European Central Bank this year.
Traders predict that the Bank of England will make one or two more quarter-point rate cuts this year, compared to the two or three expected from the ECB and a one percentage point cut by the Federal Reserve.
The recent strong performance of US Treasuries comes after the Federal Reserve chair indicated the need for rate cuts. On the other hand, the Bank of England warned that it’s too early to declare victory over inflation in Britain.
UK services inflation remains high at 5.2 per cent, despite improvements, compared to 4.9 per cent in the US and 4.2 per cent in the eurozone. Economists believe that UK interest rates will stay high as long as the economy remains robust. After falling into recession last year, the UK economy has now seen consecutive growth. Analysts predict a 1.3 per cent growth rate in 2025, up from an earlier 1.1 per cent estimate.
Some investors are concerned about the impact of heavy bond supply on gilt yields. The government issued £3.1bn of debt in July, much higher than forecasts. There are also expectations of more borrowing announced in the upcoming budget, as public finances remain a concern.
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