Investors’ Confidence Narrows as Markets Adjust to Last Week’s Monetary and Fiscal Events

Main points

• The 10-year UK government bond (gilt) yield has been on an upwards trend since January as a result of monetary policy tightening in response to inflationary pressure, caused both by supply chain disruptions and the war in Ukraine. Last week’s monetary and fiscal policy events have cemented this upwards trend: both the Monetary Policy Committee’s (MPC) decision to raise the Bank Rate by a further 50 basis points and commence quantitative tightening, and the expected medium-term inflationary consequences of fiscal loosening have increased market expectations of the path of short-term interest rates. Additionally, the uncertainty generated - in particular by the fiscal event - has led to a rise in the term premium on 10-year gilts, mirroring the global trend which had not previously affected UK investors this year.
• US 10-year Treasury yields remain above 3 per cent. Interest rate expectations continue to increase as the latest FOMC meeting on 20-21 September resulted in a third consecutive rate hike of 75 basis points as the Federal Reserve (Fed) pledged to get inflation back to target.
• German 10-year Bund yields have been increasing as well, a result of the ECB discontinuing its non-standard asset purchases as of July. Euro-area interest rate expectations continued to grow, driven by the September Governing Council decision to raise euro-area policy rates by a further 75 basis points and the rise in inflation to 5.4 per cent in July, far above the European Central Bank's target. Despite the announcement of the ECB’s new anti-fragmentation tool, the Transmission Protection Mechanism, bond yields in Italy have continued to de-couple, mainly driven by the uncertainty surrounding the future fiscal stance and recent political events.

“UK 10-year gilt yields have reached a series high since the pandemic, mainly driven by short-term interest rate expectations. Importantly, our latest figures indicate a rise in the associated term premium, likely resulting from the uncertainty caused by last week’s fiscal event. Given the intensity of inflationary pressure in the economy, the Bank of England’s upcoming quantitative tightening programme and the short-term nature of the mini budget’s firepower, it is likely that these indicators have not yet peaked.”

Paula Bejarano Carbo,
Data Analyst, NIESR

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