The pound is the worst performing currency in the G10 FX space on Wednesday, as the rout in the Gilt market continues. UK Gilts are surging at the US open, and 10-year UK sovereign yields are at their highest level since 2008. They are higher by 11 bps today. This compares with a 1bp increase in Treasury yields and a 6bp increase in French government bond yields.
The UK is looking like an outlier and is in the sights of the bond vigilantes. It feels like the UK is in a tricky spot, and with UK CPI set to be released next week, the focus on the UK bond market could continue for some time.
But is the sell off fair?
The UK currently has a lower budget deficit than the US and France at 4.7% of GDP, vs. 6.24% deficit for the US, and a 5.5% deficit for France. However, the deficit is set to rise this year and the government is set to issue more debt in 2025 vs, 2025. With growth expected to moderate, this will weigh on the deficit. Thus, other countries have their fiscal issues, but the UK is potentially on the cusp of another fiscal crisis, without either 1, intervention from the BOE or 2, government action to either raise Tax or cut spending. Neither of these are attractive options when the economy is stagnating.
Pound could be under pressure as long as bond yields continue to rise
Fiscal issues are weighing on the pound. GBP/USD is the weakest performer in the G10 today. Signs of fiscal de-anchoring occur when yields rise, but a currency falls, thus events on Wednesday do not bode well for the pound in the medium term. GBP/USD volatility has also spiked to its highest level since 2023 at 9.4%, this is still well below the levels reached in 2022, in the aftermath of the Truss Budget. To compare, 1-month EUR/USD volatility is 8.9%. Thus, it could be a bumpy ride for the pound in the coming weeks, and a break below $1.20 in GBP/USD is possible.
GBP/USD one month at the money volatility, 12 month chart
Source: XTB and Bloomberg
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