Bond yields rise as Bank of England dampens rate-cut hopes; next move may be up

Borrowing costs jumped as the Bank of England held its key rate at 4% and signaled that a timeline for future rate reductions remains unsettled. The decision, paired with the central bank’s move to slow the pace of quantitative tightening, did little to reassure markets, with the yield on 30-year gilts climbing above 5.5% at one point. Inflation in the United Kingdom remains the highest among G7 economies and well above the 2% target, a backdrop that has kept policymakers cautious about the path of policy normalization.

Governor Andrew Bailey said the bank still expects further reductions in rates, but underscored that the timing and pace of those cuts are less certain than before. “I continue to think that there will be some further reductions, but I think the timing and scale of those is more uncertain now,” Bailey said, tempering expectations that cutting cycles could come quickly. The policy decision and the QT adjustment aimed to unwind emergency support while avoiding a sharp rise in gilt yields, but markets responded by pushing up the cost of government borrowing instead.

Investors now price about a 30% chance of another rate cut this year, with the first move expected in the spring. The odds of a further cut before the end of 2026 are seen at roughly 55%. Yet some analysts warned that the next move could be higher rather than lower. George Brown, senior economist at Schroders, said: “We continue to expect rates to remain on hold this year and next, but can’t rule out the possibility that the Bank’s next move will be up, rather than down.” Brown’s view reflects the challenge of taming inflation while markets push back against near-term easing.

The shift in expectations for the path of rates comes as the government faces a tricky budget cycle. Reeves, facing a substantial funding gap in public finances, has relied on market borrowing to bridge the gap between government spending and tax receipts. A sustained rise in gilts yields increases the cost of servicing new debt, complicating projections for the autumn fiscal plan and fueling speculation about possible tax rises or spending adjustments.

The yields rally also casts a shadow over the Bank’s broader program of QT, which has been a point of contention among policymakers and pundits. Critics argue that the Bank’s sale of gilts has contributed to higher borrowing costs at a time when the economy could least bear them. The QT program, which began after the pandemic as the Bank unwound the extraordinary balance sheet expansion, reduced the supply of gilts in the market but, critics say, has also pushed up yields by thinning available government IOUs. The Bank said it would slow the unwinding process, a step welcomed by some but viewed by others as insufficient to address mounting market pressure. Carsten Jung of the Institute for Public Policy Research, a former Bank economist, said, “The Bank was right to slow the unwinding of its economic support programme. It has added unnecessary pressure on gilt yields at a time of global pressures,” while adding that the Bank could have gone further and halted active gilt sales altogether, given the ongoing inflation challenge. The Bank still holds about £558 billion of gilts, and its decisions to tighten or loosen balance-sheet policy continue to have implications for the public finances.

The Bank’s actions come against a backdrop of criticism that the QT programme has raised the cost of government borrowing and imposed losses on the Bank, all of which are ultimately borne by taxpayers and the Treasury in some form. The institution’s gilt holdings were built up during crises when rates were near zero, as the Bank bought gilts to support lending and economic activity. Since then, it has moved to unwind those holdings, a process that has stretched into the present cycle and contributed to elevated long-term borrowing costs. Supporters argue the unwind is necessary to return policy to normal, while opponents contend it has inadvertently tightened financial conditions too much for an economy dealing with persistent inflation and slow growth.

The immediate market reaction to the BoE decision underscores the delicate balance policymakers must strike between cushioning the economy and maintaining financial stability. With the autumn Budget approaching, Reeves faces the task of linking investment plans, debt management, and tax policy to a fragile macro backdrop. The path forward remains uncertain, as the central bank closely monitors inflation pressures and the evolving global rate landscape, while financial markets gauge whether the next policy move will be a pause, a cut, or an uptick in rates.

As the debate over policy direction continues, investors and policymakers alike will watch incoming data and budget-related signals for any shift in the balance between price growth and growth momentum. The coming weeks could see additional fluctuations in gilt yields as market participants reassess the odds of further rate reductions and the potential path of the Bank’s balance-sheet normalization. The broader market environment—characterized by ongoing inflation, global economic pressures, and fiscal constraints—suggests that the next few months could be volatile for government borrowing costs and for the currency as well. The Bank’s decision to slow QT and the possibility of higher or unchanged policy rates in the near term highlight the uncertain trajectory ahead for UK financial conditions and public finances.