Investing.com – The recent rise in UK government bond yields has underlined the fragility of sentiment towards the country’s fiscal position, according to Bank of America, which remains the “Achilles heel” for sterling.
At 04:35 ET (09:35 GMT), it was trading 0.1% lower at 1.2299, close to its lowest level since October 2023, and on track for a weekly loss of around 1%.
While some of the move can be attributed to the move in global fixed income, sterling has been hit by an idiosyncratic move in the GBP risk premium, which is the biggest disruptor for the pound, especially given its light positioning, analysts said from Bank of America. in a note dated January 9.
It’s too early to tell if the sterling sell-off has ended, but the disruption in skew and implied volume suggests the current bearishness is vulnerable to any improvement in sentiment via stronger growth data.
That said, the rise in government bond yields, if sustained, carries the risk that the margin Chancellor Reeves had on her fiscal rules in the October budget disappears by the time the OBR releases its spring forecasts by March publishes.
“In our view, the chances of violating or changing fiscal rules are low given the administration’s commitment to fiscal stability,” Bank of America said. “We think it is much more likely that the government will announce fiscal consolidation measures to comply with the rules and restore room for maneuver.”
“Consolidation is possible in the spring or earlier (possibly through budget cuts) and perhaps even more meaningful in the autumn. We believe that the bar for the BoE to intervene in the government bond market is high and that the comparison with the mini-budget is exaggerated.”
In addition to budget concerns, markets appear concerned about the persistence of inflation, which is further fueled by concerns about global rates, which the bank believes are justified. However, if growth weakness persists, this would complicate the decision for the BoE.
“For now, we expect inflation persistence risks to dominate the BoE’s thinking versus growth concerns, keeping them on a gradual austerity path on a quarterly basis. But if we see a sustained and major deterioration in growth and the labor market (the risks of which increase if market moves force fiscal consolidation), the BoE should pay more attention to these risks and perhaps accelerate cuts.”
