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Gilts were on track for their best week since July and the FTSE 100 hit a record high on Friday after a string of weak data weighed on sterling and prompted bets that the Bank of England will cut interest rates more aggressively to kick-start growth.
The rally in UK government bonds accelerated on Friday after official figures showed retail sales unexpectedly dropped in December, raising the risk the economy contracted at the end of last year.
The 10-year gilt yield fell another 0.06 percentage points to 4.62 per cent after the release, taking its drop to 0.22 percentage points this week. Yields move inversely to prices.
The signs of weakness on the high street follow disappointing GDP figures for November and a lower-than-forecast inflation reading in December. The IMF on Friday afternoon predicted a pick-up in UK growth this year, but the expansion is still set to be slower than in the US and Canada.
In afternoon trading, the FTSE 100 was up 1.3 per cent, taking it past its previous record high hit in May, helped by the weaker pound. Many of the companies in the blue-chip index are dollar earners, meaning they benefit from a stronger US currency.
“The better news on inflation let gilts be the safe haven asset the market now increasingly feels it needs in the UK,” said Gordon Shannon, a portfolio manager at TwentyFour Asset Management.
Rising expectations of rate cuts to support a stagnating economy had made it “easier for foreign buyers to step back in [and buy gilts]”, added Shannon.
The two-year yield was down 0.05 percentage points at 4.34 per cent on Friday, taking its drop this week to 0.19 percentage points. Sterling was down 0.6 per cent against the dollar at $1.216.
“It’s more than pound weakness,” said Luca Paolini, chief strategist at Pictet Asset Management, of the FTSE high. “I find the UK attractive as a market,” he added, saying it was “cheap” on valuation grounds and “well diversified”.
Traders now anticipate at least two quarter-point rate reductions this year from the current level of 4.75 per cent, and a roughly three-quarters chance of a third cut, according to levels implied in swaps markets.
Despite the rally in the gilt market, 10-year yields remained substantially above the 3.75 per cent level they were in mid-September, before a sell-off driven by both Treasuries and fears the UK is contending with stagflation — where persistent price rises make it difficult for the Bank of England to cut rates.
That took the UK’s borrowing costs to a 16-year high last week, the higher yields attracting a wave of retail investors but also forcing chancellor Rachel Reeves to defend her economic plans before MPs.
The rise in borrowing costs has severely curbed the headroom that the chancellor has against her self-imposed fiscal rules. Big gilt investors have warned that the government might be forced to raise taxes, or cut spending, to maintain credibility with the market.
In an update to its World Economic Outlook, the IMF said on Friday the UK economy would grow 1.6 per cent in 2025 — a 0.1 percentage point increase on the previous forecast and up from 0.9 per cent last year. UK growth would continue at a similar pace of 1.5 per cent in 2026, it said.
The outlook was welcomed by Reeves, who said the IMF forecast suggested the UK would be the fastest-growing “major European economy” over the next two years. “I will go further and faster in my mission for growth through intelligent investment and relentless reform, and deliver on our promise to improve living standards in every part of the UK,” she said.
But traders betting on rate cuts were encouraged by a speech earlier this week by one of the central bank’s rate-setters that it might need to cut rates five or six times over the coming year to support the economy.
Alan Taylor, a member of the Monetary Policy Committee, warned that recent UK data pointed to “an increasingly gloomy outlook for 2025”, as he argued the central bank needed to take pre-emptive action to support the economy with lower borrowing costs.
While expectations of lower rates will provide some relief to the chancellor when it comes to UK government borrowing costs, the poorer growth prospects that accompany them could have a negative bearing on fiscal forecasts if the weakness is judged to be persistent.
The government’s Office for Budget Responsibility is due to present its new economic and fiscal outlook on March 26, with the chancellor set to respond with a statement to parliament.
UK gilts have been helped by a trailing wind from US Treasuries, which have also rallied as data showed weaker underlying inflation pressures in the US economy. That has taken the 10-year Treasury yield down 0.19 percentage points to 4.58 per cent.
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