Is the gilt market sniffing out a Bank of England rate cut this week?

2 year uk bond yields

What does this chart say?

UK two-year gilt yields fell 3.3 basis points today, the sixth straight day of declines. The move comes ahead of the Bank of England’s interest rate decision on Thursday, with interest rate markets pricing in a 60% chance of a cut.

The bank rate is currently 5.25%, so getting to 3.85% over two years would require a significant amount of rate cuts. This highlights the downside risks to the economy as the effects of higher interest rates become more pronounced.

Sterling has been tracking the downward move in UK government bonds recently, but is still close to its highest level in the past two years. Part of that is due to the recent weakness in the US dollar as the US faces headwinds for growth. Part of it is the relief from the UK election and Labour’s promise not to raise corporate taxes or impose a wealth tax.

But in the short term, it’s all about the Bank of England in a vote that is expected to be narrowly 5-4. The BoE has repeatedly argued that domestic wage and inflation dynamics are different from those elsewhere, so it may decide to wait until another meeting before cutting rates.

By contrast, I think this kind of waiting would be bad for sterling, because it implies that the Bank of England will fall behind the curve and will eventually have to cut interest rates even deeper later to avoid a worse downturn. While I wouldn’t treat this with much confidence, it could be instructive in terms of what other central banks may soon face.

BankCutEnglandGiltmarketratesniffingweek
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