Sterling under pressure despite rising gilt yields

Conall Mac CoilleConall Mac Coille

Bank of Ireland’s chief economist Conall Mac Coille says investors remain focused on the sustainability of the UK’s finances.

Sterling has lagged the euro and other currencies in recent weeks, during the risk-off moves in financial markets as investors have reduced their dollar exposures. This is despite a notable steepening of the UK yield curve, 30-year gilt yields now at 5.35%, their highest level since the late-1990s.

This shows UK assets have failed to benefit from any perception Britain is relatively insulated from a global trade war. True, the Bank of England is expected to cut rates to 3.75% by end-2025 to support the economy.

“So Sterling is unlikely to see a sharp rebound against the Euro in the near-future, absent a far broader recovery in financial market risk appetite”

However, investors remain focused on the sustainability of the UK’s public finances. Specifically, that plans to gradually rein-in public sector borrowing from 4% of GDP appear to rely on unrealistic assumptions on spending and optimistic projections for GDP growth.

So Sterling is unlikely to see a sharp rebound against the Euro in the near-future, absent a far broader recovery in financial market risk appetite.

Pounds and pence

Sterling lags behind: Sterling has depreciated sharply against the euro through April, the exchange rate at 85.9p this morning, having started the month at 83.5p. Despite appreciating to $1.32 against the dollar, sterling has lagged behind other currencies as risk-off moves following the imposition of US tariffs led investors to move away from dollar assets. UK assets clearly haven’t benefitted from any perception Britain will be relatively insulated from a global trade war. Rather, as in the US, concerns around the UK’s fiscal position and functioning of the gilt market persist.   

Expectation for rate cuts put downward pressure on short-end of the curve: Options are currently fully pricing in three 25bp cuts from the the Monetary Policy Committee by end-2025, beginning at the next policy meeting on May 8th, and with a 45% probability of a fourth to 3.5% by March 2026. News this week that private sector regular earnings growth slowed to 5.9% in February and CPI inflation 2.6% in March, have encouraged this view, putting downward pressure on the short-end of the curve. Hence, 2-year gilt yields have fallen by 15bps since the beginning of April, now at 4%.    

Concern around UK’s fiscal sustainability persist: Chancellor of the Exchequer Rachel Reeves’ March Fiscal Statement did little to rein-in the public finances. Public sector borrowing of 4% of GDP is expected in budget year 2025/26, forecast to gradually reduce to 2% of GDP by 2029, but relying on spending assumptions the Institute for Fiscal Studies (IFS) have deemed unrealistic and a pick-up in GDP growth to 1.9% in 2026. The Office for Budgetary Responsibility (OBR) has warned poor productivity performance could hinder the UK from achieving this expected rebound in GDP growth.

Long-end of the curve driven upwards: UK 10-year and 30-year gilt yields peaked on April 9th at 4.78% and 5.63% respectively. Though falling back since then, they remain well above the levels seen during the fall out from Liz Truss’ ‘mini-budget’ in 2022. The pick-up in term premia that investors now demand for holding duration on UK gilts has meant the 30-year yield is now at its highest level since the late 1990s, steepening the curve. Such has been the market volatility, the Bank of England put-off an auction of long-term gilts, due on April 14th, as part of its quantitative tightening (QT) programme. 

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Conall Mac Coille
Conall Mac Coille
Conall Mac Coille is the chief economist at Bank of Ireland. He began his career as an economist in the Economic and Social Research Institute (ESRI), Dublin, before moving to the Bank of England in September 2002. He has also lectured in macroeconomics at the Dublin Institute of Technology. During his time in the Bank of England he worked in the International and Structural divisions of the monetary analysis area before moving to the Monetary Policy Committee unit in September 2008. He was principal advisor to two MPC members in succession, Professor David Blanchflower and Professor David Miles. He has published several articles on the trade performance of the UK economy in the Bank of England's Quarterly Bulletin. In 2009, he published a paper with Professor David Blanchflower on the formation of inflation expectations in the National Bureau of Economic Research (NBER) working paper series. He has written extensively on the Irish economy, formerly as co-author of the ESRI's Quarterly Economic Commentary and in his current role as Chief Economist in Ireland's leading brokerage. As early as 2001, he warned in an Irish Banking Review article, that the social partnership model of wage bargaining was inappropriate within EMU and in an Economic and Social Review paper that inflationary pressure would threaten Ireland's competitiveness. He has contributed widely to the national and international broadcast media, including RTE, TV3, BBC, ITV, Sky News, Bloomberg, CNBC, Newstalk and Today FM, and is regularly quoted in the Irish print media on developments in the Irish economy. His research and Davy economic forecasts for the UK economy have been quoted in the Financial Times amongst other media.

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