Gold ticks up but remains pressured by Fed rate caution, easing trade fears
Investing.com -- UK gilt yields have fallen by more than 30 basis points since early October, providing some relief for Chancellor Rachel Reeves ahead of her November 26 budget announcement.
The decline in yields has been driven by renewed Bank of England rate cut expectations and growing investor confidence in a market-friendly budget outcome. This market movement could provide the Treasury with nearly £5 billion in additional fiscal headroom.
According to ING analysts, the risk premium in 10-year gilt yields has compressed significantly, though they still remain about 7 basis points higher than predicted on an FX-hedged basis compared to other major government bonds.
The pound has weakened during this period, with EUR/GBP breaking above 0.880 and GBP/USD dropping 0.8%. ING attributes this currency movement to adjustments in Bank of England expectations rather than increased risk premiums on UK assets.
Reeves faces a fiscal shortfall of approximately £25 billion per year, which is expected to be addressed through extending tax threshold freezes, applying national insurance to landlords and partnerships, raising bank taxes, and increasing taxes on dividends and certain capital gains.
ING believes the recent gilt rally may be reaching its limits, with only about 5 basis points of potential further decline in 10-year yields if the remaining risk premium is removed. The bank expects three more rate cuts from the Bank of England, with a growing possibility that the first could come in December.
The analysis presents four potential budget scenarios and their market implications:
In the base case, the Treasury delivers the expected fiscal tightening, which would have limited additional impact on gilts and sterling.
In a scenario where Reeves implements more aggressive fiscal tightening, including potential income tax increases and spending cuts, gilt yields could fall further while sterling might weaken modestly.
If the budget is prudent but includes inflationary measures, short-dated yields could rise and sterling strengthen, potentially pushing EUR/GBP down to 0.850-0.855.
In a worst-case scenario where the budget fails to deliver sufficient fiscal sustainability, 10-year gilt yields could spike by around 20 basis points, triggering a severe pound sell-off that could push EUR/GBP above 0.90.
The analysis suggests that while this is not a UK sovereign crisis, the market response to the upcoming budget will depend heavily on the balance between fiscal tightening, inflation impacts, and credibility of the government’s approach.