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UK gilts rallied sharply on Tuesday as traders seized on comments from a senior Bank of England policymaker suggesting it may be willing to consider interest rate cuts in the middle of next year.
The yield on the interest rate-sensitive two-year gilt fell to 4.59 per cent, its lowest level since June, after comments from Huw Pill, the BoE’s chief economist, late on Monday. It was recently trading at 4.64 per cent, down 0.08 percentage points on the day. Yields move inversely to prices.
The declines come as investors shift their focus from interest rates needing to stay high to curb global price pressures to the prospect of weaker economic growth.
Speaking after markets had closed on Monday, Pill said the BoE could be in a position to “consider or reassess” its stance on rates in the middle of next year depending on how the economic prospects evolved.
Market expectations for cuts next summer were not “unreasonable”, he said, while adding that it was unlikely that nothing would happen over the next nine months to change the outlook.
“Huw Pill’s dovish comments overnight have given fresh fuel to the gilt rally, causing the market to price even more in the way of rate cuts,” said Daniela Russell, head of UK rates strategy at HSBC.
“It was a bit of a surprise to hear him validate market expectations for cuts in the middle of next year and it marks a change from the persistent higher for longer narrative that we’d heard up until that point,” she added.
Benchmark 10-year gilt yields fell 0.11 percentage points on Tuesday to just below 4.27 per cent, the lowest level since September, while sterling fell 0.3 per cent against the dollar to $1.23.
Government bonds across the US and Europe have rallied sharply over the past week after a string of weaker than expected economic data and downgrades to the BoE’s growth forecasts.
Benchmark US Treasury yields have fallen 0.28 percentage points over the past week, the biggest weekly decline since the collapse of Silicon Valley Bank in March.
“Global yields have been moving together since Friday’s payroll data,” said Lyn Graham-Taylor, a rates strategist at Rabobank. “It’s all variations of a theme — we had a massive bid for bonds on Friday, an unwind on Monday and a bit of a bid again today,” he said.
Official figures from Germany on Tuesday showed industrial production fell for the fourth consecutive month in September, taking third-quarter output in the sector down 2.1 per cent and adding to the gloom over Europe’s largest economy.
Ten-year Bund yields — the benchmark for the eurozone — fell 0.06 percentage points on Tuesday to 2.68 per cent.
Swaps markets are now fully pricing in the first rate cuts for the Federal Reserve and the European Central Bank in June next year. The UK’s first rate cut is priced for August.
Analysts attributed the rally in short-dated gilts to the market bringing forward its expectations for the BoE’s rate cuts. The market has priced in a rate of 4.54 per cent by December next year, down from 4.75 per cent at the start of the month.
“The UK is playing catch-up in terms of pricing in rate cuts for next year as the global narrative has turned to a weaker growth outlook over the last week” said Megum Muhic, senior associate strategist at RBC Capital Markets.
The central bank has stressed it expects to keep rates on hold for an extended period as it combats inflation, while declining to define that period specifically. Last week, it predicted a stagnant period for UK economic growth next year, while warning that risks to the inflation outlook remained “skewed to the upside”.
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