Summary

• UK 30-year gilt yields jumped to 5.73% midweek before easing to 5.50% after Bank of England (BoE) Governor Andrew Bailey said the surge was “overdone” with too much “drama”

• At the short end, Bailey warned there is “considerably more doubt” on the pace of rate cuts, a slight shift in tone from last month’s dovish stance

• Markets now see only <50% chance of another BoE cut this year, with mid-September’s meeting and Consumer Price Index (CPI) print as the key inflection point

• US nonfarm payrolls showed just 22k jobs added in August and unemployment up to 4.3%, pushing the 10-year treasury yield down 15bps to 4.07% and reinforcing September US Federal Reserve (Fed) cut expectations.

Market review

Long-end: Bailey provides ballast

Long-dated UK government bond yields pushed higher at the start of the week before BoE Governor Andrew Bailey stepped in with some ballast. Speaking on Wednesday, Bailey argued that the surge in long-end yields was overdone and that there was too much unwarranted “drama”.

The structural backdrop has shifted against gilts. Natural demand for long-dated paper has faded as defined benefit (‘DB’) pension schemes have largely completed their liability hedging, while new defined contribution (‘DC’) pension schemes have little appetite for such long-duration assets.

At the same time, the Treasury has been slow to meaningfully scale back long-end issuance, while the UK’s fiscal trajectory has become more precarious. With ‘price insensitive’ buyers (DB pensions) stepping back, more yield-sensitive investors (us) are demanding a higher risk premium.

This has left gilts underperforming their developed market peers, where yield curves have also steepened. Germany’s 30-year bund yield touched a 14-year high of 3.4% midweek, underscoring how global the pressures have become. The 30-year gilt yield peaked at 5.73% on Wednesday before staging a sharp rally in the second half of the week to finish at 5.50% – still at levels not seen since the late 1990s.

Bailey’s comments reassured markets that the BoE could curb their own sales of gilts (quantitative tightening) built up from over a decade of quantitative easing. The BoE are due to decide the annual pace of its quantitative tightening program later in September.

With the UK Budget now scheduled for late November – a deliberately delayed date to give the government as much time as possible – long-dated gilts will likely remain under pressure. Every move higher in yields feeds back into the UK’s fiscal arithmetic, raising borrowing costs and further eroding the Chancellor’s already narrow headroom.

Importantly, both the BoE and Debt Management Office retain levers to mitigate further gilt declines - from scaling back QT to adjusting long-end issuance - though the long-term stability of the gilt market ultimately hinges on policy credibility.

Short-end: Bailey provides bite

In contrast, the short end of the yield curve, more sensitive to the current monetary cycle than to fiscal dynamics, was unsettled by Bailey’s remarks. He told the Treasury Committee that there is “now considerably more doubt about exactly when and how quickly we can make those further steps” referring to rate cuts. The path to easier policy is now less certain.

Earlier this year the UK’s Monetary Policy Committee released a potential interest rate path under a “persistent inflation” scenario, where the bank’s base rate remains at 4% – where it currently is – until 2028. This confirms that the BoE will now keep policy on hold until there is clear evidence of disinflation.

Deputy Governor Clare Lombardelli reinforced caution last week, noting that inflation is likely to remain between 3.5% and 4%, leaving the Bank’s current policy rate “not meaningfully restrictive” – very much in line with the Bank’s own ‘persistent inflation’ scenario.

Bailey, who had supported a cut last month, appears to have struck a more hawkish tone, at least temporarily, seemingly prioritising sticky inflation over the weakening economy.

Two-year gilt yields nudged higher briefly surpassing 4.0%, though the real inflection point is likely to arrive mid-September, when the BoE meets again and fresh inflation data for August is released. The market is pricing in a little under a 50% probability of a further rate cut this year.

US labour market data

Global bond markets found a tailwind from a weaker-than-expected US labour market. Friday’s nonfarm payrolls report showed just 22k jobs added in August, well below estimates, while the unemployment rate ticked up to 4.3% – the highest since 2021.

The softer labour picture added to expectations that the Fed may ease policy in September, helping underpin global bond yields in the second half of the week. The 10-year US Treasury yield fell 0.15% to close at 4.07%.

The week ahead

Thursday: European Central Bank (ECB) rate decision

Our thoughts: With the ECB’s deposit facility rate now at 2.0% - around the perceived long-run neutral - the central bank is widely expected to keep policy on hold as it waits for greater clarity on the economic trajectory. Markets lean toward further easing down the line, with swaps pricing a 75% probability of a cut in 2026.

Thursday: US CPI inflation

Our thoughts: Headline CPI is expected to edge up to 2.9% year-on-year from 2.7%, while core inflation is seen steady at 3.1%.