Market News

By Greg Ritchie and James Hirai

(Bloomberg) -- Long-term UK government borrowing costs are approaching the highest level since 1998 as investors struggle to work out how much the Bank of England will cut interest rates next year.

The yield on 30-year bonds climbed as high as 5.16% on Friday after rising for seven consecutive sessions, on course for the highest close in 26 years. In just one week, the market has gone from wagering on the possibility of four interest rate cuts next year to fewer than two, and then back to entertaining the chance of three.

At the heart of the debate is the question of how policymakers will respond to the UK’s difficult mix of persistent inflationary pressures and lackluster growth. The unclear outlook is adding yet another headwind for gilt investors as they brace for an increase in supply next year. Borrowing is on track to overshoot official forecasts this year, raising the risk that the government will have to come back for more money early next year.

“2025 is shaping up to be a huge year for the gilt market in terms of both issuance and assessing whether the year-end moves in yield will be behind us,” said Ed Hutchings, Head of Rates at Aviva Investors.

A third of the Bank of England’s monetary policy committee dissented Thursday by voting to cut interest rates — more than the market had expected — and Governor Andrew Bailey cited “heightened uncertainty in the economy” as the reason he “can’t commit to when or by how much” rates will be cut in the coming year.

A contracting economy and signs in the BOE’s survey of businesses across the UK that the labor market is weakening contrast with data released this week showing that wages increased more than forecast. That’s against a backdrop of fiscal stimulus announced in October as well as global spillovers from US policy. The Federal Reserve signaled a refocus on price risks on Wednesday, while on Friday President-elect Donald Trump threatened the European Union with tariffs.

A typical gilt portfolio has fallen over 4% in 2024, according to a Bloomberg index. That compares to a 2% return for euro government bonds and a roughly flat year for a US Treasury benchmark.

“BOE officials appear more divided than ever on the path ahead for UK interest rates,” said Matthew Ryan, head of market strategy at Ebury. That reflects “the complex outlook for the UK economy, as fragile consumer demand is counterbalanced by the pro-inflationary implications of the Autumn Budget and Trump’s tariff proposals.”

Of course, uncertainty breeds opportunities. Should UK price pressures ease in 2025, as many economists expect, the BOE could end up cutting rates more aggressively, fueling a bond rally.

“The three members who voted for a cut now may be proved right, for the risk is that the six who voted to keep rates unchanged are focusing too much of the recent spate of higher than expected inflation figures, and not enough on the weak growth data,” said Guy Stear, Head of Developed Markets Strategy at the Amundi Investment Institute. “We think the BOE can cut rates up to five times next year.”

Yet gilt bulls have been consistently disappointed this year. At the start of 2024, markets were betting on around 150 basis points of BOE cuts over the course of the year. In the end, only 50 basis points materialized, less than both the Fed and the ECB.

“We’re still on the rate-cutting track but the inclement economic weather means we are on go-slow,” said Susannah Streeter, head of money and markets at Hargreaves Lansdown.

(Updates to add background throughout.)