UK gilts reverse gains as investors eye fiscal fragility and global rate risks

UK bonds retreated on Thursday, erasing the gains made after Wednesday’s announcement of a smaller-than-expected debt plan. 

Investors quickly shifted their focus to the nation’s precarious fiscal position and the broader risks of rising global borrowing costs.

UK gilts under pressure as rising yields threaten Reeves’ fiscal buffer

Gilts declined across the curve, underperforming their European counterparts and pushing the benchmark 10-year yield up by as much as eight basis points to 4.81%—its highest level since mid-January when a global bond selloff severely impacted Chancellor Rachel Reeves’s fiscal flexibility.

Although Reeves yesterday restored her fiscal buffer to exactly where it was in October, firms including BlackRock Inc., Allspring Global Investments and Fidelity International say the UK bond market remains very much at the mercy of external forces. 

Lauren van Biljon, senior portfolio manager at Allspring Global Investments, noted: “Reeves has very limited headroom, and potential domestic and international shocks are numerous.”

The concern is that rising global bond yields, persistent inflation, and weaker-than-expected growth could trigger another selloff in UK bonds, once again eroding Reeves’ fiscal buffer. 

The Office for Budget Responsibility cautioned that this headroom could vanish entirely if U.S. President Donald Trump imposes 20% tariffs on global trade or if borrowing costs increase by just 0.6%.

UK fiscal woes cast a shadow over gilts ahead of autumn budget

Vikram Aggarwal, fixed-income investment manager at Jupiter Asset Management, said the deterioration in UK public finances can’t be underestimated. He noted that the cheapness of gilts doesn’t make them an attractive buy.

The fragile state of the UK’s finances is heightening expectations that the government may need to raise taxes or implement further spending cuts in October’s Autumn Budget. The Office for Budget Responsibility estimates a 46% chance that Reeves will breach her fiscal rule requiring taxes to cover day-to-day spending.

Shamil Gohil, fixed-income portfolio manager at Fidelity International, said that Gilts will probably remain in no man’s land until the Autumn budget. He added that they will likely see some fiscal slippage and buffer erosion.

UK bonds rally on borrowing plan, but fiscal risks loom large

Market movements have been erratic, with gilts experiencing sharp fluctuations driven by shifting investor sentiment. 

On Wednesday, UK bonds posted one of their strongest performances of the year following the Debt Management Office’s announcement of a smaller-than-expected borrowing plan. Yields on 30-year notes dropped by as much as nine basis points—their biggest decline since early February.

Pooja Kumra, senior UK and European rates strategist at Toronto Dominion Bank, attributed Wednesday’s bond rally primarily to the favourable issuance figures. However, she emphasized that the underlying reality remains unchanged, with the UK still trapped in a difficult fiscal position.

Some funds, including Vanguard, took confidence from the government’s firm re-commitment to its fiscal rules, saying the relative cheapness of gilts outweighed the risks around the UK’s economic trajectory.

Ales Koutny, head of international rates at Vanguard, reinstated his long-dated gilts position against Germany. He noted that Reeves’ firm stance on fiscal rules being non-negotiable has helped ease concerns about shrinking fiscal headroom. He expects UK bonds to realign with U.S. yields in the coming months.

Markets have wavered for months in their approach to UK gilts, shifting between buying for their high yields and selling over fears that the Labour government may struggle to manage the nation’s deficit. 

Vivek Paul, UK chief investment strategist at BlackRock, noted that the country’s borrowing costs remain highly vulnerable to spikes, suggesting gilts could face renewed pressure.

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