UK gilt yields above 5% as Iran ceasefire collapse hits bonds
The collapse of the US-Iran ceasefire has driven UK 10-year borrowing costs above 5% as surging oil prices force traders to price in further Bank of England rate hikes.
UK 10-year gilt yields climbed as much as seven basis points on Tuesday morning, passing 5% for only the third time since the Iran war began. The move follows the collapse of a 60-day ceasefire, with the US and Iran exchanging strikes for a third successive night.
Brent crude surged more than 9% on Monday, its largest daily gain since May 2020, after the US reinstated a blockade of Iranian ships in the Strait of Hormuz and the UAE reported two tankers struck by Iranian missiles. The return of all-out conflict threatens to reverse the downward trajectory in energy prices achieved during the June truce.
Government bond yields rose across developed economies, with the 10-year US Treasury yield adding more than five basis points on Monday. However, the sell-off has been most severe in the UK due to the economy's heavy reliance on imported energy and persistent underlying inflation, which eats into the real returns of fixed-income investors.
Shorter-dated UK debt reflected the shifting monetary policy expectations. The two-year gilt yield jumped 10 basis points to trade above 4.5% for the first time since mid-May, as traders increased bets on a Bank of England rate hike at its 30 July meeting.
The market is also pricing in a 40% probability that the Federal Reserve will raise interest rates when it meets this month.
The spike in borrowing costs creates an immediate fiscal headache for Andy Burnham, who is due to officially become Prime Minister in a matter of days. The prior ceasefire had provided significant relief to public finances, pulling the 10-year yield down by more than half a percentage point from its May peak.
