2yr Gilts Preferred

Still less than stellar 2025 growth will likely encourage the BOE to cut a further 100bps in 2025.  This should led to a consistent decline in 2yr yields, as future BOE monetary policy report will effectively endorse some further easing embedded in market rates – the BOE forward guidance is also better than the ECB for example.  Also the current discount of 2yr to the bank rate is not excessive and is similar to numerous discounts seen in the pre GFC period and was much larger in 1998.  Thus we can see a decline in 2yr yields to 3.6% by end 2024.  We then see 3.35% by end 2025, as 2yr yields tend to swing towards a premia versus the Bank Rate in mid to late part of an easing cycle.  Market sentiment will also split on how low BOE bank rate can go.  

10yr yields will decline marginally in absolute terms in 2024 helped by BOE easing and a modest decline in 10yr U.S. Treasury yields.  However, the normal yield curve switch to a positive yield will likely mean that the decline is much slower than 2yrs.  We do see the BOE slowing the pace of QT and this could come as early as H2 2024 (here).  It is fine for the BOE to continue QT in the early stages of an easing cycle, but the BOE have admitted that QT is contractionary and a slowing will likely be evident once the rate cutting cycle speeds up in H2 2024.  However, given the size of gilt holdings, the BOE will remain biased to carrying on some QT. Our view is for 10yr Gilt yields to 3.90% by end 2024.   For end 2025, we see 3.80% as rate cuts still help, but the 10-2yr yield curve will steepen further.   

Figure 1: CE BOE Bank Rate, UK 2yr and 10yr Yield Forecasts (%)

Source: Continuum Economics