Gilt yields near Mini Budget highs after hotter-than-expected UK inflation

The UK headline CPI rate of 8.7% in April surprised to the upside, despite falling from 10.1% in March. The reading was above both economist expectations of 8.2% and the 8.4% projection from the Bank of England earlier this month. 

While the headline figure fell, core CPI rose to its highest level since 1992, at 6.8% versus the forecast 6.2%, adding to fears inflation is becoming entrenched and forcing markets to increase their terminal interest rate predictions.

The 2-year gilt ended the day up by 23.7bps at 4.35%, according to data from MarketWatch, approaching the highs found during the Liz Truss Mini Budget fallout, which triggered a mass sell-off of UK assets, while the 10-year yield was up 5.6bps at 4.21%. 

Mini Budget triggers plunging pound and massive gilt sell-off

Gilt yields have continued to rise today (25 May). At the time of writing, 2-year gilt yields had risen to 4.48%, the highest level since 27 September 2022’s 4.61% peak, while 10-year yields are at 4.33%, closing in on its 4.51% peak from the same day, according to data from MarketWatch.

Excluding the Mini Budget period, the increase of 2-year gilts is on track to be the largest weekly rise since June 2008.

The sell-off was reminiscent of the Truss era, according to AJ Bell head of investment Alena Kosava, who said the real worry for markets and investors at this point is the potential need for the BoE to turn more hawkish and further tighten monetary policy.

This comes at a time when the Bank was widely considered to be nearing the end of the tightening cycle, she added. 

Markets are now pricing three full rate hikes this year, and possibly a fourth, bringing the forecast terminal rate as high as 5.5%, a considerable rise from an expected peak of 4.8% at the end of last week, and the current 4.5% level. 

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The prospect of a terminal rate well beyond previous expectations brings senior fixed income strategist at Saxo Bank Althea Spinozzi’s focus to the front of the yield curve, which she said will remain under pressure in the following months.

“If 2-year gilt yields break above the 4.68% level, they will find resistance next at 5.57%, a level last seen in June 2008,” she said. 

“Following the events of last fall, it is clear that the financial system cannot take rates that high yet; hence, it is safe to assume that the central bank will not allow rates beyond 5% and step in to cool off the sell-off earlier than that.”