UK In the Bond Vigilantes' Sights says XTB's Brooks

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The UK’s fiscal position continues to look perilous as we start trading on Thursday.

The relentless rise in UK yields has continued but at a slower pace. UK Gilt yields have risen once more at the open, the 10-year yield opened higher by 5 bps, although yields have recovered slightly as we progress through the morning.

However, the UK bond market is once again underperforming the rest of Europe. On Wednesday, the UK bond market sold off heavily after the US market opened, so there could be further downside to come, although there is a shorter trading day in the US on Thursday due to President Carter’s funeral.

The sell-off in UK bonds this week is a warning shot from the bond vigilantes

The UK is reliant on investors to fund its deficit. The UK is not unique in needing this, however, the US can fund its deficit more easily because the USD is the reserve currency, and the Eurozone as a whole runs a surplus.

Since the market’s focus so far in 2025 has turned to the sustainability of public sector finances, the UK is understandably in the firing line.

The weakness in UK bonds has seeped into other UK assets.

The pound has sunk further, and GBP/USD is back below $1.23, and it has touched its lowest level in more than a year on Thursday.

The pound is now the weakest currency in the G10 FX space so far this year. This is quite the fall from grace, last year it was top of the G10 FX space for most of the year. As we mentioned yesterday, when a currency falls and bond yields surge it suggests a de-anchoring of the bond market and can be a warning sign that a fiscal event is about to happen.

Why the UK is in the bond vigilantes’ sights

The Chancellor is expected to make a speech in the coming days, where she may focus on public sector spending cuts rather than further tax increases to meet her fiscal rules. However, the rhetoric from the Labour government is one reason we are in this mess in the first place, and there are no guarantees that Reeves will be able to calm the market.

The market price action is a damning reflection of the Labour government’s economic policies so far, and it suggests a lack of confidence in their ability to fuel economic growth in the UK.

In a short space of time, the UK economy has gone from growing at a decent pace to slowing down sharply, which is causing wobbles in the bond market. The Labour market needs to drive growth urgently, but it does not appear that there is a plan to do so.

A rise in debt sales since the budget, fears of stagflation and a global backdrop of rising bond yields is a perfect storm for the UK. Although Donald Trump’s recent speeches have caused anxiety in financial markets this week, the rise in bond yields are also down to domestic factors.

Reeves is in tricky fiscal waters, and her plans to put the UK on a secure fiscal footing are in tatters. Her limited fiscal headroom has already been wiped out by the relentless rise in bond yields in recent months, and she is in danger of breaching her own fiscal rules.

Although we are not in a Liz Truss style moment, this is largely because pension funds have changed their structures so they are less exposed to a rapid and unexpected rise in Gilt yields. However, there is no doubt that the UK Gilt market is experiencing a crisis in confidence, which follows on from a draining of business and consumer confidence.