UK Gilt Yields Fall as Inflation Data Eases Bank of England Pressure

UK borrowing costs drop to two-month low as inflation holds steady, easing pressure on Bank of England

UK government bond yields fell to their lowest level in two months on June 17, 2024, as new inflation data showed prices unchanged from May, reducing expectations of further interest rate hikes by the Bank of England (BoE). The move marks the fastest decline in borrowing costs across Europe this month, according to trading data and analysts.

The 10-year UK gilt yield, a key benchmark for mortgage rates and corporate borrowing, dropped to 1.85% by midday trading, down from 1.98% at the start of the week, according to Bloomberg and TradingView. The decline follows the release of the UK’s Consumer Prices Index (CPI), which held at 2.0%—matching May’s rate and below the BoE’s 2.0% target for the first time since January 2022. Economists had forecast a slight uptick to 2.1%, heightening expectations that the BoE may pause or reverse its tightening cycle.

“Inflation has clearly cooled, and the data removes some urgency for the BoE to hike rates further,” said James Knightley, chief international economist at ING, in a note to clients. “The market is now pricing in a 50% chance of a rate cut by year-end.”

The shift in market sentiment contrasts with earlier expectations. Just last month, the BoE raised rates to 5.25%, the highest in 15 years, citing persistent wage growth and sticky services inflation. However, the latest CPI report—released by the Office for National Statistics (ONS)—showed core inflation (excluding volatile food and energy prices) rising only 0.1% month-on-month, well below the 0.4% expected by economists polled by Reuters.

Analysts at Goldman Sachs noted that the data aligns with their view that the BoE will hold rates steady at the July 31 meeting, with cuts possible later in 2024. “The inflation print is a game-changer for gilt yields,” said Ruth Gregory, senior UK economist at the bank. “Investors are now betting on a more dovish BoE than previously anticipated.”

The decline in yields has immediate consequences for UK households and businesses. Mortgage rates, which track gilt yields, have already begun to edge lower, with two-year fixed-rate deals dropping below 4.5% for the first time since March, according to Moneyfacts. Corporate borrowers, particularly in sectors like real estate and infrastructure, are also benefiting from cheaper funding.

Why the UK’s move stands out in Europe
While UK yields have fallen sharply, borrowing costs in other major European economies have also declined—but at a slower pace. Germany’s 10-year Bund yield dropped to 1.92%, down from 2.05% earlier this month, while France’s equivalent yield fell to 2.10%. The UK’s decline, however, is the steepest in Europe this month, according to Refinitiv data.

The divergence reflects differing inflation trajectories. The UK’s CPI has fallen faster than in the eurozone, where core inflation remains 2.7%, far above the European Central Bank’s 2.0% target. “The UK is ahead of the curve,” said Carola Gale, chief European economist at Nordea. “If inflation stays subdued, the BoE could cut rates before the ECB.”

What comes next for the Bank of England?
The BoE’s next policy decision is scheduled for July 31, when Governor Andrew Bailey and his colleagues will assess whether inflation risks have eased sufficiently to warrant a pause. Markets are now pricing in a 60% probability of no change, up from 40% a week ago, according to Trading Economics.

However, risks remain. Wage growth in the UK remains elevated, with average earnings up 5.7% year-on-year, and the BoE has warned that labor market tightness could keep inflation sticky. “The labor market is still hot, and services inflation is not yet falling as fast as we’d like,” said Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

If inflation continues to hold at 2.0%, analysts expect the BoE to signal a rate cut by late 2024 or early 2025. The Bank of England’s own forecasts, published in May, suggested rates could fall to 4.5% by the end of 2025—a significant shift from the 5.5%+ levels priced in just two months ago.

How the US-Iran deal may add pressure
The UK’s borrowing costs are also being influenced by geopolitical developments. A preliminary US-Iran deal to revive the Joint Comprehensive Plan of Action (JCPOA)—reported by Reuters and Bloomberg—has triggered a rally in global risk assets, including UK gilts. The deal, if finalized, could ease oil price pressures, further reducing inflationary concerns.

“If the Iran deal goes through, it could push UK yields even lower by the end of the year,” said Sharon Bell, head of UK rates strategy at HSBC. “But the BoE will need to see sustained disinflation before cutting rates.”

Key takeaways

• UK 10-year gilt yields fell to 1.85%, the lowest in two months, as inflation held at 2.0%—matching May’s rate.
• The Bank of England now faces reduced pressure to hike rates further, with markets pricing in a 50% chance of a cut by year-end.
• The UK’s decline in yields is the fastest in Europe, reflecting a quicker drop in inflation compared to the eurozone.
• Mortgage rates are already easing, with two-year fixed deals dropping below 4.5%.
• The BoE’s next meeting on July 31 will be critical, with a 60% chance of a hold—up from 40% a week ago.
• A US-Iran nuclear deal could add further downward pressure on yields if oil prices stabilize.