“Should the Bank Of England step away from the market today as suggested, we could see gilt yields rising, and the feedback loop of selling of gilts, as pensions schemes struggle to maintain hedges, re-assert itself. To some extent, gilt yields, real and nominal, have repriced to reflect recent fundamental developments, but they have also faced intense technical headwinds, increasing volatility and placing further upwards pressure on yields. Fiscal announcements could influence yields in either way, depending on the markets view of their credibility
“Indeed, yields are potentially even above the levels implied by longer-term economic fundamentals, assuming the Bank of England’s mandate remains intact and the government’s real GDP growth target of 2.5% year-on-year proves to be extremely optimistic, as most economists suggest. However, we believe a shift away from the ultra-loose monetary, and tight fiscal, policy that characterised much of the post-GFC era may mean the normalisation of yields we have always assumed over the longer-term has been accelerated. Assuming inflation does return to target over the medium-term, in line with consensus forecasts, both nominal and real yields may ease back. Due to recent moves in real yields, and allowing for high current inflation and RPI/CPI reform in 2030, implied inflation does not look particularly expensive.
“The technical headwinds noted above include a large increase in gilt issuance, given the UK’s sharply deteriorating fiscal position, concerns over near-term inflationary pressures, and potential gilt sales by the Bank of England (currently postponed to 31st October). Furthermore, pension schemes have been forced to liquidate collateral, and in some cases, reduce hedging levels, increasing the supply of gilts to the market even further. While the Bank of England is providing temporary support to the market and further support cannot be ruled out, given their mandate for financial stability, the underlying technical picture is not a positive one.”
|
