Plunging UK Markets Offer Fresh Warning Over Economy and Pile Pressure on Starmer
(Bloomberg) -- Plunging UK markets are serving a fresh warning about the British economy and heaping pressure on Keir Starmer’s embattled Labour government.
While UK bond yields have been creeping higher in recent months, anxiety in markets kicked into overdrive this week, with long-simmering worries about inflation and Labour’s spending plans hitting a nerve.
Gilt yields topped multi-decade peaks on Wednesday, with the 10-year rate soaring to the highest since 2008 and the 30-year yield at the highest since 1998. The moves were exacerbated thanks to similar worries bubbling up in the US about incoming President Donald Trump’s tax-cut and tariff policies.
In a sense, the moves are a culmination of the UK representing all of the worst case scenarios for investors right now: persistent price pressures, a ballooning government debt pile and tepid economic growth. Plus, the UK economy, like much of Europe, is at risk from the tariffs promised by Trump — even if some economists see it as less impacted that elsewhere in the region.
“You are getting that negative feedback loop in the UK whereby higher yields means higher borrowing and therefore feeding greater fiscal concerns. That’s quite specific to the UK,” said Marcus Jennings, fixed income strategist at Schroders. “Investors are concerned about a stagflationary environment.”
Stocks and the pound have also been pummeled. The FTSE 250 Index, which tracks mid-cap companies, sank 1.9%, the most since August. The UK currency is approaching $1.23, the weakest level in 13 months.
As well as causing significant losses to bondholders, the rise in yields is also a problem for officials: Chancellor Rachel Reeves’ self-imposed fiscal rules mean that, should yields remain elevated, she will likely need to raise taxes or reduce spending.
“This seems like a bit of a slow burning equivalent to what happened around the time of the Liz Truss budget,” said Neil Birrell, chief investment officer at Premier Miton Investors. “We’re hitting the point where markets are saying it doesn’t work. You can’t raise that level of taxes and make those sort of spending cuts and think that’s going lead to growth.”
The way the bond market losses rapidly snowballed this week without any obvious catalyst gives a sense of how fragile market sentiment is. The fact the rise in rates came alongside a slump in the pound also unnerved traders. Usually, higher bond yields boost currency values.
“Although there’s not any sign of a crisis yet, this is potentially evidence of a buyer’s strike and potential capital flight,” said Mike Riddell, portfolio manager at Fidelity International.
Traders said it’s unlikely that UK markets will follow the same path as 2022, when Liz Truss introduced an ill-fated budget. The liability-driven investment strategies at the heart of that turmoil now must hold larger cash buffers in order to reduce the chance of another liquidity crisis. The BOE is also developing a repo facility that will allow these funds to raise cash in the event of future turbulence.
Much of the moves also reflect positioning rather than fundamentals, with the higher yields available in the UK attracting many investors. Sterling was the only Group-of-10 currency that leveraged funds were net long against the dollar, according to Commodity Futures Trading Commission data for the week ended Dec. 31.
In any case, the fact UK markets appear prone to such sudden fits suggests a frailty that’s likely to deter international investors. Despite any differences to today, the memories of the 2022 gilt crisis are still fresh and the UK’s economic challenges remain unresolved.
“Myriad factors contributed to the stretch higher, including Labour’s spending ambitions, sticky inflation, higher US rates and supply pressures,” said ING strategists led by Michiel Tukker. “We still see gilt yields settling lower later in the year, but as long as these factors linger, a change in direction may take some time.”
--With assistance from Michael Msika and James Hirai.