Investing.com – The recent rise in UK gilt yields has highlighted the fragility of sentiment about the country's fiscal situation, said Bank of America, which remains the “Achilles' Heel” for sterling.
At 04:35 ET (09:35 GMT), it traded 0.1% lower to 1.2299, near its lowest level since October 2023, and on track for a weekly loss of around 1%.
While part of the move may be due to the move in global fixed income, sterling has been hit by an unusual move in the GBP risk premium which is a major distraction for the pound, especially with the light conditions, according to analysts at Bank of America, in a note dated January 9.
It is too early to tell if the sterling sell-off has ended, but the movement in skew and implied vol indicates that the current bearish trend is likely to develop. the sentiment through stronger growth data.
That said, the rise in gilt yields, if it continues, raises the risk that Chancellor Reeves' room against his fiscal rules in the October Budget will disappear by the time the Work out their Spring predictions around March.
“In our view, there are chances that the fiscal rules will be broken or changed, as the government commits to fiscal stability,” Bank of America said. “We think it is much more likely that the government will announce measures fiscal consolidation to meet the regulations and restore the room.”
“Consolidation is possible in the Spring or earlier (perhaps through spending cuts) and perhaps more sensible in the Autumn. We believe that the bar for BoE involvement in the Gilt market is high and that comparisons with the small budget are too much.”
In addition to fiscal concerns, markets appear to be concerned about the stability of inflation, further fueled by global tariff concerns, which the bank sees as warranted. However, with growth weakness if it continues, it would make BoE trade difficult.
“For now, we expect inflationary stability risks to dominate BoE thinking against growth concerns, keeping them on a gradual seasonal cut path. But if we see sustained and significant growth and a contraction in the labor market (and if risks increase if the market moves to fiscal consolidation), the BoE would need to turn more attention to these risks and perhaps accelerate cuts.”
