UK Gilt Yields Seen Falling as Government Looks to Rebuild Fiscal Headroom

Analysts expect UK gilt yields to fall in the coming months, potentially helping the government restore some of its lost fiscal headroom ahead of the 28 October budget.

This prediction comes weeks after Andy Burnham's new government took office and as John Healey prepares for his first budget as chancellor. According to analysts and investors, the UK's inflation outlook is supportive of interest rate cuts, while concerns about the credibility of Kevin Warsh, the new chairman of the US Federal Reserve, may also lead investors to choose gilts over other assets.

Markets are currently pricing in two Bank of England rate rises over the next year, but Daniel von Ahlen, a strategist at TS Lombard, believes there is a higher likelihood that borrowing costs will be cut 'as the labour market remains in the doldrums'. The UK's inflation outlook has improved, with the past three inflation readings undershooting the Bank of England's estimates.

Gilts have been among the worst-performing government bonds this year, but they outperformed their peers in July, when total monthly returns on UK bonds were flat, compared to a 1.2% fall for US treasuries and a 0.7% decline for German bonds.

The UK's borrowing costs could also fall further as the Bank of England is expected to reduce the pace at which it sells gilts on its balance sheet back to investors, according to analysts at Bank of America. They predict that the annual pace of quantitative tightening will be cut from £70 billion to £50 billion from September.