Key Takeaways
- Bond market volatility expected around the Autumn Budget.
- Two more rate cuts are expected this year.
- Bank of England bond sales could be key.
- Longer-term yields have risen.
UK Bond Markets Are Watching Politics
The first half 2025 has seen significant moves in global bond yields, with volatility triggered by events such as US tariffs, the Middle East conflict, interest rate cuts and Europe‘s ambitious defense spending.
UK gilts have mirrored these trends closely, with a range of domestic factors also impacting the market. So what should investors expect in the second half the year? We look at political risk, monetary policy, bond supply and global trends. And examine whether the UK gilt market is benefiting from the rotation out of US Treasuries, and how that is reflected in the actions of asset managers.
Starting with political risk, the Labour government has navigated two key events this year without triggering bond market volatility, March 26’s Spring Statement and the Spending Review on June 11. But the toughest test lies ahead, with the Autumn Budget due in late October or early November. Here the chancellor lays out tax and spending plans for the coming year and has to convince the markets that the job of “restoring stability to our public finances” is on track. New spending commitments, such as on defense, may lead to tax rises in the autumn, some experts believe—see our May article, Bond Managers Fear Rachel Reeves Will Break Fiscal Rules.
Bond Markets Nervous, But Not Panicking
While bond markets will be closely watching the government’s fiscal plans for the rest of the year, there’s “nervousness, but no panic,” says Mark Preskett, Morningstar Wealth portfolio manager. Despite spikes along the way, the 10-year gilt is lower than at the start of the year and at the start of the second quarter. He expects volatility to increase in the runup to the Budget, as it tends to do. But recalling the 2022 Mini Budget, which toppled the prime minister and chancellor amid a currency and bond crisis, “the risk of a 2022 style selloff is very low.”
David Roberts, comanager of the Bronze-rated NedGroup Global Strategic Bond Fund, is also sanguine about the state of the UK’s public finances.
“The UK’s fiscal position looks not too bad,” he says, comparing the UK favorably with Germany, which has lifted the “debt brake” to allow government spending, and to the US, where debt-to-GDP is expected to rise sharply. He also expects some UK bond market volatility in the buildup to the next UK “fiscal event”, but sees this as a “wonderful tactical opportunity” if bond prices slide.
It’s important to be aware of political risk, he adds, but “economics normally wins out over politics.” UK inflation and interest rates are not high by historical standards and the “state of the internal economy is much better shape than many people imagine.”
Steepening of the UK Yield Curve
Fund managers note that the UK is subject to global trends such as a steepening of the yield curve, where the gap between short and long-term yields has widened. For example, the yield on the 30-year UK gilt has increased by 65 basis points since June 2024, a trend also seen in the US, Japan and Germany. Short-term yields have fallen in line with interest rates, which were cut in February and May.
This increases a government’s long-term borrowing costs, but also raises the yield investors will receive for lending to a sovereign over three decades. NedGroup’s Roberts says that the steeper yield curve is part of a “normalization” in the bond market, after a period when investors were not being paid a big enough premium to lock their money away.
Ultimately this is not just a UK problem, says David Katimbo-Mugwanya, head of fixed income and manager of the EdenTree Global Sustainable Government Bond Fund.
“Concerns around fiscal discipline are therefore weighing heavily not just on the UK but also across most major economies where governments are seeking to boost growth via increased spending in the United States and Europe.”
Where Next for Interest Rates?
Bond market prices also reflect the likely path of interest rates: overnight index swaps show that markets expect two further cuts, in August and November, which would take the base rate down to 3.75%: see a recent article, Will the Bank of England Cut Interest Rates in 2025?
UK gilt yields are higher than in Europe because key interest rates are higher, which is due to our inflation rate also being higher: an annual rise of 3.4% rather than 1.9% in the eurozone. Central banks use interest rates to tame inflation: the Bank of England raised rates from 0.1% to 5.25% to curb double-digit inflation, which then fell back to the 2% target (before rising again).
UK interest rates have been on a downward path since August 2024, and the Bank describes this as “a gradual and careful approach to the further withdrawal of monetary policy restraint.”
Another tool in the BoE’s armory is quantitative tightening (QT), where the central bank sells the UK government bonds it acquired during the period of quantitative easing (QE), a tool used in the post-financial crisis period when the Bank wanted to stimulate the economy with lower rates.
Bank of England is Selling UK Debt
The Bank acquired nearly £900 billion of UK sovereign debt after 2008, a pile that has since fallen to around £600 billion with waves of bond sales. Catherine L. Mann, a member of the Bank’s monetary policy committee, said in a speech in June that these bond “sales are designed to be gradual and predictable, in the background, and, unlike QE, are conducted during calm times rather than times of markets or economic stress.”
Given the size and impact of this holding, are these bond sales “flooding the market” with UK debt, depressing prices and supporting yield? Some fund managers are proposing that the Bank slows this process down to avoid oversupply of debt. A decision on the next phase of QT is due in September, with a new schedule to be followed in October for another year.
Morningstar’s Preskett is skeptical about this theory, noting that many of the Bank’s gilt holdings will be held to maturity anyway and will expire, curbing the supply of new bonds into the market. He compares the UK position with Germany, which is expected to issue billions of euros of new debt to finance spending, including on defense.
What about bond supply? The UK’s Debt Management Office (DMO), which manages bond auctions on the government’s behalf, is expected to focus on selling shorter-term rather than longer-term debt, Preskett says. Bond auctions held so far this year counter the idea that investors are shunning UK debt: auctions for debt for a range of maturities in May and June have been two to three times oversubscribed, including an issue that matures in 2063.
Retail investment platforms also report sustained interest in gilt issues from nonprofessional investors. While this is unlikely to move prices, experts say, the yields on offer are still comparatively appealing for bond investors. See the article, Want to Buy UK Government Bonds?, for a comparison of the risks of cash versus bonds.
Are UK Assets a Safe Haven?
When it comes to global trends, one market narrative in the tariff era has been that investors have been rotating away from dollar-denominated assets, with the related thread that US Treasury bonds have started to lose their “safe-haven” status. Could UK bonds benefit from this flow of money away from the US into Europe? Morningstar Wealth has been upping its allocation to UK debt, especially in its latest June portfolio rebalance, Preskett says.
He argues also that despite the pound’s recent strong run against the dollar, it may have further to go, increasing the appeal of sterling-denominated assets. UK assets can be a safe-haven, he says, “if not the safest haven.” What works in the UK’s favor is very low default risk, strong credit rating, a central bank that “acts rationally” and world-renowned governance, he says. While the UK government is under pressure over its fiscal plans, Labour won a strong majority at the 2024 election and will not face voters until the end of the decade.
Still, the Japanese yen, Swiss franc and US dollar will retain their dominance as safe-haven currencies, he says.
Asset Managers Are Buying UK Debt
Looking at the midyear outlooks from global asset managers also supports the idea that UK debt could see strong demand in the rest of the year: HSBC Asset Management says it’s increasing its exposure to UK and German 10-year debt, reducing its exposure to Japan’s equivalent debt, and maintaining a neutral position to US debt.
“As traditional safe havens have become less effective, new safety substitutes, such as European duration, Asian fixed income, and gold gain relevance,” the bank said.
Goldman Sachs Asset Management also argues that central banks will cut interest rates in the rest of the year, which will lower yields and increase government bond prices.
“We anticipate weaker global trade and growth will likely reinforce dovish monetary policy actions in Europe (even though the ECB has expressed confidence in the resilience of the eurozone economy to the trade shock).”
