Gilt markets are always a bit nervous heading into the Autumn Budget announcement, and this year is no different. We estimate the risk premium embedded in the 10Y gilt yield to be around 20bp, whereas this was close to zero a few months ago. Overall though, global factors continue to be the bigger driver of sterling rates and with energy hitting new highs, we don’t expect this to change.
Gilt auction results held up relatively well leading up to this budget, whereas last year’s auctions reflected more nervousness. The bid-to-cover ratios and yield tails in the three auctions preceding the 2025 budget announcement showed some weakness. However, this is not evident in the most recent 10yr gilt auction last week. And also Tuesday’s 6yr gilt auction showed healthy demand.
But we do think a bit of a relief rally could take place as the budget turns out to be than Burnham’s ambitions would imply. Also, last year the auctions just after the budget looked slightly better and gilts rallied on the shortening of issuance maturities. An unwinding of the risk premium would offer up to 20bp of relief for 10yr gilts. Of course, a could turn the story quite bearish as this would compound with energy-related inflation fears.
Broader political risks, however, are likely to stay, and for markets to deal with. We’ve learnt from France that markets attach more value to political stability than to the decimal place of the fiscal deficit. If Burnham decides to reopen the political battleground, we can expect investors to take a more cautious approach again to gilts. Until inflation is under control, any government spending promises would quickly translate to more upward pressure on gilt yields.