Gilts rallied sharply on Monday as Rishi Sunak was confirmed as the UK’s new prime minister, with investors betting that the former chancellor would stick to the economic policies that have calmed markets in recent days.
UK government bond prices had leapt in early trading after Boris Johnson’s exit from the Conservative party leadership race on Sunday. They extended their gains after Penny Mordaunt pulled out to leave Sunak as the only remaining candidate, pushing UK government borrowing costs back down close to the levels seen prior to last month’s controversial “mini” Budget, which triggered a gilt market meltdown.
The 10-year gilt yield sank 0.32 percentage points to trade at 3.73 per cent on Monday, reflecting a sizeable rise in price. The pound climbed by as much as 0.9 per cent against the dollar in early trading before falling back amid a broad rise for the US currency to trade little-changed on the day at $1.1295.
The departure of Johnson from the contest brought relief to markets that had wobbled on Friday at the prospect of the former prime minister’s return to Downing Street. Sunak is seen by investors as far more likely to back the fiscal plans of the new chancellor Jeremy Hunt, which helped to restore order to the gilt market.
“Rishi Sunak stands a much better chance of bringing stability to government,” said Derek Halpenny, head of research for global markets at MUFG. “He will not have a privileges committee investigation into lying to parliament that Boris Johnson has and will command credibility from financial markets given his strong opposition to the economic policies of Liz Truss.”
Ten-year yields remain above levels of roughly 3.5 per cent seen prior to Truss’s ill-fated fiscal plans last month, which sent gilts and sterling into a nosedive, triggering a liquidity crisis at pension funds and prompting the Bank of England to step in with an emergency bond-buying programme. But shorter- and longer dated gilt yields fell back to roughly where they were before September 23.
Investors had also bet that the BoE would be forced to raise interest rates rapidly to prop up a falling pound and offset the inflationary effects of £45bn of unfunded tax cuts.
Interest rate expectations had begun to fall back down following Hunt’s announcement last week that he would scrap most of Truss’s tax-cutting measures.
They moderated further on Monday. Traders expect BoE interest rates to rise to just above 5 per cent by next summer, compared with 5.25 per cent last week.
The move comes after Ben Broadbent, the Bank of England’s deputy governor for monetary policy, last week cast doubt on market expectations that rates would need to rise to more than 5 per cent to bring down inflation.
Two-year gilt yields, which are highly sensitive to rate expectations, fell 0.29 percentage points to 3.42 per cent.
“The last three months effectively got wasted for everyone,” said Pooja Kumra, a rates strategist at TD Securities. “We have reversed nearly the entire move in gilts, as well as the fiscal plans. But in the meantime the recessionary environment has got worse which limits how much the BoE will need to tighten.”
Monday’s moves were being exaggerated as investors with negative bets on gilts were being forced to throw in the towel and buy, according to Kumra. “There’s a big short position in gilts, and suddenly the short position is getting torn up,” she said.
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