Why higher term premia will slow the fall in gilt yields
Fiscal pressures, shifting gilt demand, and higher issuance are keeping yields elevated despite a more dovish Bank of England outlook
We think the 10-year gilt yield will only fall modestly this year, before declining further through 2027 and 2028. In our view, further disinflation and weak activity growth will lead the Bank of England’s Monetary Policy Committee to cut Bank Rate further than markets expect, more than offsetting the upward pressure on yields from moving into a regime with structurally higher term premia.
The financial market reaction to November’s UK Budget was relatively muted, but we expect gilt yields to fall over the next couple of years as the Bank of England’s Monetary Policy Committee gradually shifts to a more dovish policy stance.
However, rising term premia suggest progress on bringing down yields is likely to be slow. The UK’s fiscal position remains relatively poor and markets are being asked to digest very elevated levels of gilt issuance while the BoE continues its quantitative tightening programme. This also comes at a time when the global supply of highly-rated government bonds is increasing sharply.
Meanwhile, structural changes in the pension sector point to weaker gilt demand from what has been a large and relatively price-inelastic purchaser, particularly at the long end. The emerging marginal buyer of gilts appears to be flightier, more price-sensitive, and favour shorter duration. So the Debt Management Office will continue to shift supply towards shorter maturities. This highlights the need for the UK government to develop a credible fiscal strategy focused on reducing borrowing and targeting politically challenging impediments to growth.
Download the full report to see how rising term premia, heavy issuance, and shifting investor demand are reshaping the outlook for gilt yields.
