UK Bond sell off eases for now

UK Bond sell off eases, but pound is under pressure

The UK’s fiscal position continues to look perilous as we start trading on Thursday. The relentless rise in UK yields has continued but at a slower pace. UK Gilt yields have risen once more at the open, the 10-year yield opened higher by 5 bps, although yields have recovered slightly as we progress through the morning. However, the UK bond market is once again underperforming the rest of Europe. On Wednesday, the UK bond market sold off heavily after the US market opened, so there could be further downside to come, although there is a shorter trading day in the US on Thursday due to President Carter’s funeral.

The sell off in UK bonds this week, is a warning shot from the bond vigilantes. The UK is reliant on investors to fund its deficit. The UK is not unique in needing this, however, the US can fund its deficit more easily because the USD is the reserve currency, and the Eurozone as a whole runs a surplus. Since the market’s focus so far in 2025 has turned to the sustainability of public sector finances, the UK is understandably in the firing line.

The rise in bond yields continues to weigh on the pound

The weakness in UK bonds has seeped into other UK assets. The  pound has sunk further, and GBP/USD is back below $1.23, and it has touched its lowest level in more than a year on Thursday. The pound is now the weakest currency in the G10 FX space so far this year. This is quite the fall from grace, last year it was top of the G10 FX space for most of the year.  As we mentioned yesterday, when a currency falls and bond yields surge it suggests a de-anchoring of the bond market and can be a warning sign that a fiscal event is about to happen.

Why the UK is in the bond vigilantes’ sights

The Chancellor is expected to make a speech in the coming days, where she may focus on public sector spending cuts rather than further tax increases to meet her fiscal rules. However, the rhetoric from the Labour government is one reason we are in this mess in the first place, and there are no guarantees that Reeves will be able to calm the market. The market price  action is a damning reflection of the Labour government’s economic policies so far, and it suggests a lack of confidence in their ability to fuel economic growth in the UK. In a short space of time, the UK economy has gone from growing at a decent pace to slowing down sharply, which is causing the wobbles in the bond market. The Labour market needs to drive growth urgently, but it does not appear that there is a plan to do so.

A rise in debt sales since the budget, fears of stagflation and a global backdrop of rising bond yields is a perfect storm for the UK. Although Donald Trump’s recent speeches have caused anxiety in financial markets this week, the rise in bond yields are also down to domestic factors. Reeves is in tricky fiscal waters, and her plans to put the UK on a secure fiscal footing are in tatters. Her limited fiscal headroom has already been wiped out by the relentless rise in bond yields in recent months, and she is in danger of breaching her own fiscal rules.

Although we are not in a Liz Truss style moment, this is largely because pension funds have changed their structures so they are less exposed to a rapid and unexpected rise in Gilt yields. However, there is no doubting that the UK Gilt market is experiencing a crisis in confidence, which follows on from a draining of business and consumer confidence.  

UK retailers sink as risk sentiment falters

Equity markets are mostly lower today, although the FTSE 100 is eking out a small gain. However, there is a notable flood to safe havens in the UK index. The retail sector is facing a sharp selloff and M&S is down more than 7%. This comes even though the company reported strong sales during the Christmas period. The company reported a 5.6% increase in total group sales in the 13 weeks to December 28^th. This was driven by stronger than expected food sales, of £2.58bn, with food sales rising by 8.9%. Growth in clothing, home and beauty was 1.9%, and international sales sunk by 2.8%. The company sounded positive on the outlook for the coming quarter and reported strong online demand. M&S joined the chorus of retailers and complained about the rise in taxes, which will push up its costs and it said that the external environment remains challenging.

While the sell off in M&S seems unwarranted since its trading update was decent, the market is targeting UK listed companies with a domestic focus. The FTSE 250 is down by 0.8% and Tesco, the UK’s biggest grocer by market share, is also lower by more than 2% on Thursday. This comes even though it reported a strong Q3 earnings report and kept its forecast for its fiscal fourth quarter unchanged. The market is in jittery mood and is happier to sell than to buy today.