By Miriam Mukuru
Short-dated U.K. government borrowing costs have jumped as markets priced in the risk of aggressive interest-rate rises by the Bank of England.
High energy prices due to the Middle East war have stoked fears of possible rebound in U.K. inflation. This could force the Bank of England to increase interest rates even as the economy struggles.
Investors are fully pricing in three quarter-point interest-rate rises by the BOE in 2026, including an 87% chance of a rate increase in April, LSEG data showed. This is a remarkable shift from expectations for two interest-rate cuts in 2026 prior to the start of the Middle East war.
Yields on two-year U.K. government bonds, also known as gilts, rose 10 basis points to 4.600% on Friday, edging close to the 4.714% level, a near two-year high hit on Monday, Tradeweb data showed. The two-year yield is up by more than 100 basis points since the start of the Middle East war almost four weeks ago.
The speed of the rise in the two-year gilt yields has only been surpassed during the 2022 gilt crisis when the then-Prime Minister Liz Truss announced unfunded tax cuts, Derek Halpenny, MUFG's head of research for global markets EMEA, said in a note.
"The scale of increase in yield in the U.K. has been huge," he said.
U.K. inflation expectations are the main drivers of higher gilt yields currently.
"Short-term rate expectations have been shaped by rising inflation expectations, with markets expecting the Bank of England to react aggressively to the expected rise in CPI," Sanjay Raja, Deutsche Bank chief U.K. economist, said in a note.
Due to rate hike expectations, short-dated gilt yields are rising faster relative to long-dated gilt yields, causing the gap between them to tighten. The spread between two-year and 30-year gilt yields narrowed to last trade at 107 basis points, from 150bps prior to the war, Tradeweb data showed.
"Concerns about inflation and, as a consequence, central bank rate activity, appear to have eclipsed worries about the effects of rising geopolitical risks on the back of the U.S. conflict with Iran," Mitch Reznick, group head of fixed income at Federated Hermes, said in a note.
Yields on the benchmark ten-year gilt rose 11 basis points to last trade at 5.065%, approaching the near 18-year high of 5.118% hit this week.
Write to Miriam Mukuru at miriam.mukuru@wsj.com
(END) Dow Jones Newswires
March 27, 2026 09:04 ET (13:04 GMT)
Copyright (c) 2026 Dow Jones & Company, Inc.
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