(Bloomberg) -- UK assets entered a second week of declines amid growing consternation about the government’s large fiscal deficit and key inflation data this week that may show price pressures remain elevated.
Sterling was the worst-performing Group-of-10 currency on Monday, dropping as much as 0.9% to $1.2100, the lowest since November 2023. Gilts fell with global peers, pushing the 10-year yield back toward last week’s peak of 4.92% — the highest level since the global financial crisis in 2008.
Investors are on edge ahead of Wednesday’s inflation report, as a re-acceleration in consumer-price growth in December could boost the case for even higher yields. UK bonds emerged as a particularly weak link amid a global selloff given concerns over persistently high inflation and the nation’s stretched public finances.
“In the current market environment where the ongoing selloff in gilts is creating more concern amongst market participations over the government fiscal positions, even a stronger UK inflation report could be viewed more negatively for the pound,” Lee Hardman, senior FX strategist at MUFG wrote in a note.
Economists surveyed by Bloomberg forecast Britain’s consumer price growth was unchanged at 2.6% last month, above the Bank of England’s 2% target. Signs that price pressures are reigniting could unleash further market volatility.
Options trading suggests the pound’s weakness will persist. One-month risk reversals, a measure of market sentiment, show traders are the most bearish since December 2022. Meanwhile, the cost of hedging sterling swings over the coming month rose to the highest since March 2023.
“The UK has suffered the most of the G-10 in 2025,” said Bob Savage, head of markets strategy and insights at BNY. “The UK data may set off one theme for others in 2025 – ‘new stagflation’ where fiscal and monetary policy aggravate growth leaving inflation stuck.”
What Bloomberg strategists say...
“There is far more to the relentless increase in gilt yields than just what is happening to Treasuries. The two-year inflation breakeven rate in the UK has climbed an emphatic 70 basis points since Chancellor Rachel Reeves unveiled her autumn budget, outlining ambitious borrowing and spending. The increase in yields isn’t just a secondary-market phenomenon that the UK government can ignore.”
— Read the full note from MLIV strategist Ven Ram here.
To be sure, the pound’s losses also reflect the dollar’s strength as traders slash wagers on the extent of interest-rate cuts from the Federal Reserve this year. A blowout US employment report on Friday underlined the resilience of the US economy, leading money markets to price less than one quarter-point reduction in borrowing costs this year.
“We have a very strong dollar and the dollar is rising against many, many currencies,” Jim O’Neill, member of the UK House of Lords and former chairman at Goldman Sachs Asset Management said in a Bloomberg TV interview.
Investors will closely follow a sale of 30-year inflation-linked UK bonds on Tuesday and an offering of 10-year gilts on Wednesday. Last week, an auction of long-term debt was the least oversubscribed since 2023, while new five-year notes were met with solid demand.
On Monday, the Bank of England successfully sold £750 million of its gilts holdings despite calls for it to pause its quantitative-tightening program. The auction was 2.24 times oversubscribed, only slightly below the 2.66 average cover ratio for short-dated bonds since the start of last year.
The yield on 10-year gilts rose as much as six basis points on Monday, adding to a 25-basis-point jump last week, before partly reversing the move. The market rout drew comparisons with a meltdown two years ago that toppled former prime minister Liz Truss, heaping pressure on the fiscal plans of current Chancellor Rachel Reeves.
Pound Traders Are Ready for Another 8% Slump After Selloff
Gordon Shannon, portfolio manager and partner at TwentyFour Asset Management, said the firm is underweight UK rates. While “meaningful” spending cuts could spur a recovery in UK markets, he expects Reeves to resist any such move for now to keep alive her goal of boosting long-term growth and investment.
UK stocks were also hit in the selloff, with the domestically-focused FTSE 250 posting its worst week since June 2023. The index was flat on Monday, while the large-cap FTSE 100, mostly comprised of export-oriented constituents, fell 0.3%.
The sterling primary market has been ticking along, although it hasn’t been tested by non-financial UK corporates yet. Motability Operations Group plc, a London-based provider of transit services, will likely be the first after it finishes investor meetings on Tuesday.
--With assistance from Naomi Tajitsu and Vassilis Karamanis.
(Updates with result of the QT sale in 11th paragraph.)
