UK bond yields surge as government ramps up borrowing more than expected

UK bond yields surged and prices plunged as markets priced in a more aggressive pace of tightening to offset the government’s fiscal stimulus and as traders balked at the prospect of heftier-than-expected debt issuance.

The yield on five-year bonds jumped as much 51 basis points to 4.07 per cent, set for the biggest increase on record through 1992. Traders ramped up their wagers on Bank of England rate hikes, betting on a 50 per cent chance of a 100-basis-point increase from the central bank at its next rate decision in November, according to swaps linked to decision dates.

Bond yields usually rise when prices fall, and vice versa.

The repricing comes as prime minister’s Liz Truss’s government set out the most radical package of tax cuts for the UK since 1972, reducing levies both on worker pay and companies in an effort to boost the long term potential of the economy. The additional fiscal stimulus though will complicate matters for the Bank of England, as it supports consumer demand just as policymakers move to tamp down on inflationary pressures.

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“Clearly the prospect of more debt-financed tax cuts is spooking gilt investors, said Antoine Bouvet, senior rates strategist at ING. “It’s a perfect storm for gilts.

The nation’s debt management office (DMO) increased its gilt sales plan for 2022-23 by £62.4 billion (€69.8 billion) to £193.9 billion to fund the spending, more than expected. Strategists fear it forms another pressure on the currency, as a ballooning debt pile makes the UK more reliant on external capital flows to finance its deficit.

The extra supply from the UK government might prove especially challenging for the gilt market now that the Bank of England is also offloading bonds from its portfolio after years of buying. The central bank said Thursday it plans to sell around £10 billion in gilts each quarter starting on October 3rd.

The additional debt sales planned by the DMO will also see an increase in the proportion of short- and medium-maturity debt versus what was initially slated in April.

Totted up, the market may have to digest around three times the pre-pandemic average over the coming years after accounting for previous BOE bond-buying, according to a NatWest Markets estimate made before the DMO’s revised plan. The ballooning debt sales are needed to fund sweeping measures from Liz Truss’s new government. — Bloomberg.