Headquarters of the London Stock Exchange
by Amanda Cooper
The pound sterling is heading towards its biggest three-session fall in almost two years on Thursday, amid rising bond yields around the world, with the British gilt particularly affected by the movement after climbing to a 16-year high and a half, as concerns mount over the state of Britain’s finances.
Thursday morning, the pound sterling was down 0.9% to $1.226, after falling during the session to its lowest since November 2023. The British currency is heading for a third consecutive session in the red, carrying its losses on this period at around 2%, the largest drop since February 2023.
Against the euro, the pound fell 0.6% to 83.93 pence, a two-month low.
Investors are concerned about rising inflation, a possible reduction in the pace of interest rate cuts, and how the new US administration of President-elect Donald Trump will conduct its foreign or economic policy. The prospect of issuing trillions of dollars of additional debt has sent bond yields soaring around the world this week.
THE GILT AT A PEAK SINCE 2008
Among the world’s major economies, the British market has been hit the hardest. Yields on Britain’s benchmark 10-year bonds rose a quarter point this week to their highest level since 2008, as confidence in Britain’s fiscal outlook deteriorates.
Ordinarily, higher yields support the pound, but that relationship has broken down, reflecting investor concern about the country’s finances.
“With the weakening of the pound, there are growing questions about whether the Bank of England (BoE) can cut rates as quickly as expected,” says Jim Reid, strategist at Deutsche Bank.
“So, overall, this rise in yields increases the risk that the government will break its fiscal rules and have to announce new consolidation measures (tax hikes and/or spending cuts), while the weakening of the currency will accentuate inflationary pressures at the same time,” he adds.
In a press release published Wednesday evening, the British Ministry of Finance assured that its commitment to respecting budgetary rules was not negotiable.
But rising borrowing costs add to the hurdles Finance Minister Rachel Reeves already faces. It plans to sell hundreds of billions of pounds of bonds this year to finance public services and investment to boost growth while adhering to government rules limiting debt and spending levels.
The pound sterling has been one of the best performing currencies against the dollar over the past two years, largely due to the Bank of England’s policy of keeping its policy rates at higher levels than those of other major central banks.
-PIMCO NOT WORRIED
In the United States, the future American president, who will take office on January 20, has committed to raising customs duties on imports and toughening immigration laws, which risks fueling pressure on prices and limit the ability of the US Federal Reserve to reduce rates. This caused the dollar to skyrocket against virtually every other currency.
The derivatives market shows that traders believe the Fed will make just one rate cut this year, while the US central bank expects two rate cuts.
The British market, for its part, displays almost identical expectations regarding the BoE.
The UK faces weak growth, persistent inflation and a deteriorating labor market. The country lags behind the United States, which demonstrates resilience in virtually all areas.
The premium demanded by investors to hold 10-year British government securities rather than U.S. Treasuries jumped to around 20 basis points, its highest level since early November.
The yield on 30-year UK government bonds also rose to its highest level since 1998 this week, in the wake of rising long-term yields around the world.
We have to go back to September 2022 to observe strong turbulence in the British bond market when the short-lived Prime Minister Liz Truss presented a mini-budget providing for billions of pounds of unfunded tax cuts. This led to his resignation and forced the BoE to intervene to stabilize the market.
Despite the current turmoil in the UK bond and money markets, Pimco, one of the world’s largest bond investors, said it remained positive on UK government bonds.
The US bond fund, which has $2 trillion in assets under management, believes much of the rise in UK yields is linked to the rise in their US equivalents.
“Even though UK-specific factors like the budget contributed to the rise, most of the increase was linked to the rise in US Treasury yields over the same period,” he told Reuters Peder Beck-Friis, economist at Pimco.
(Reporting by Amanda Cooper; with contributions from Harry Robertson; French version by Claude Chendjou, editing by Kate Entringer)
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