UK bond yields have surged recently, reinforcing UBS’s view that the Bank of England will cut interest rates in February, with more rate cuts expected this year.
The rise in UK bond yields began with a rise in US bond yields after the US election, with UK-specific concerns only coming into focus last week, UBS analysts said in a note dated January 13.
The budget, with tax hikes targeting businesses, has dented already fragile confidence. Growth missed expectations in the third quarter of 2024, and this weakness is expected to continue in the near term.
The bigger problem, however, the Swiss bank added, is the decision to leave very limited fiscal space if things don’t go as planned, as is currently the case with this rate hike.
The additional cost of servicing the UK’s national debt puts the Chancellor’s fiscal targets in jeopardy when the Office for Budget Responsibility publishes them for the Spring Statement, something Rachel Reeves may have to address.
The Chancellor has so far ruled out a tax hike in the spring, so spending cuts are the option. However, this may not be as easy as it seems. The main component of the budget is a sharp increase in public spending.
According to UBS, “recent events give me greater confidence that the Bank of England will not simply be a bystander. Higher borrowing costs, which are flowing through to the real economy, are tightening financial conditions. Inflationary pressures are present but are easing, so a rate cut in February, with more later this year, remains the basis of our expectations.”
