Key Takeaways
- Yields on UK government bonds have spiked since the start of the Iran war.
- Markets have scaled back expectations of UK interest rate cuts, causing yields to rise.
- Bond fund managers say gilts could provide value if energy prices begin to stabilize.
The global market selloff after the outbreak of the Iran war has caused UK government bond prices to fall sharply amid a drastically changed outlook for interest rates and inflation.
The yield on two-year gilts, which are particularly sensitive to interest rate movements, spiked from around 3.60% before the outbreak of the Iran war to nearly 4% on March 9-near, a six-month high, before falling back on March 10.
When yields on bonds rise, their price falls as investors demand to be paid more for lending their money.
According to Morningstar economist Grant Slade, UK bond yields have risen since the start of the war because traders are reducing expectations of interest rate cuts from the Bank of England, amid fears of a rise in inflation.
Energy supply chain disruption has sent oil prices spiraling since the start of military action in the Middle East. And as the UK is a major energy importer, it is exposed to a potential inflationary shock.
In a speech to the House of Commons on March 9, Chancellor Rachel Reeves warned UK inflation is likely to rise in the coming months.
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Craig Veysey, head of fixed income at Guinness Global Investors, says UK government bonds have been hit particularly hard because they had already rallied on expectations of further Bank of England interest rate cuts prior to the conflict. Futures markets had considered a March 2026 rate cut a “done deal” after four rate cuts in 2025 and two in 2024.
While the most significant moves have been felt in short-duration bonds, which are most sensitive to rate changes, a similar story was also seen in longer maturities, with 10-year yields rising to a six-month high of 4.80%.
“The market had become quite complacent about inflation, and that has now been abruptly reversed,” says Veysey.
“This is an inflation repricing story. Safe havens do not work in the usual way when bonds have already rallied hard, yields are near their lows, and markets suddenly have to worry about inflation again.”
“I am not especially surprised by the move,” he adds. “Gilts are a market that can overshoot when positioning is crowded and the macro narrative shifts quickly. That is what we are seeing now.”
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While the market movements have been sizable, the UK market is not alone in feeling the impact of the potential inflationary shock.
Charles Stanley head of fixed income research, Oliver Faizallah, says the extent of the UK bond moves has been unusual, especially given that the UK and Europe are marginally more susceptible to inflation risk than the US.
“The moves we’ve seen in gilts over the past two to three days have been extraordinary—we haven’t seen that kind of volatility for quite some time, and it’s been across the entire curve,” he says.
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While yields are much higher than they were a month ago, they are still lower than where they were in March last year across the board, excluding the longer-dated 30-year government bonds. Last year saw a spike in UK yields in January, because of global moves in long-term bonds, and in the autumn, as traders worried about the return of domestic political risk.
However, Bryn Jones, head of fixed income at Rathbones, says uncertainty around the length of the conflict makes it harder to assess the longer-term outlook for the bond market.
Gilt yields eased slightly in early trading on March 10 after US President Donald Trump suggested the war could end “very soon”, which caused oil prices to climb down from over USD 100 a barrel.
“A long, protracted war is not good for longer term inflation and hence why we have seen yields rise,” Jones says.
“What we have said in the past is that it’s difficult to predict President Trump’s behaviors, comments and moves. This ‘Trump Bingo’ has been going on for a while. The front-end has also seen some aggressive repricing.
“If you think the inflation fed through is not going to be that bad, and a conclusion to this trouble is forthcoming, then clearly there could be a lot of value.”
Oil Prices and Gilt Yields
Indeed, if oil prices stabilize, this could send bond yields lower once more. Nedgroup Investments fixed income head, David Roberts, says if oil prices climb down toward the USD 80 a barrel mark in the coming months, Bank of England policymakers may be able to “look through” the inflationary spike and may be more tempted to cut.
He also says a sharp upward move in energy prices is better for bonds than a drawn out series of rises over months.
“The so called ‘base effect’ means that in a few months’ time oil may well be materially lower than current spot prices, meaning disinflationary forces are at work.”
Guinness GI’s Veysey adds that “gilt yields are becoming attractive again” at current levels.
“There is clearly a risk that energy prices stay higher for longer if the conflict drags on, and central banks are far too early in the process to react.
“But if yields move further out of proportion to the underlying UK economic data and/or energy prices begin to stabilize, my bias would be to be a buyer of gilts.”
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