By late February, UK bond yields had fallen decisively, with analysts noting that declining interest rates, both at home and in the United States, and lower inflation expectations were prompting greater investor confidence in government bonds (gilts). As such, the UK bond market was making progress in reversing the alarming rise in yields observed during much of 2025.

“Risk premium in gilts has evaporated. Yields are much closer to our long-term fair value estimates,” ING noted in a report published on February 26. But the outbreak of major conflict in the Persian Gulf just two days later sent yields soaring once again, and with them, concerns over the UK’s financial stability.

On the eve of the war (February 27), the yield on the United Kingdom’s 10-year gilt—a benchmark for measuring the government’s long-term borrowing costs—was trading at 4.23 percent, the lowest in about 18 months. By the end of April, the yield had climbed sharply, trading above 5.06 percent. “The markets are feeding off the developments in the Middle East and the associated worsening outlook for energy prices as well as the possible policy reaction [from the central bank],” Paul Dales, chief UK economist at Capital Economics, told the Financial Times on March 20. With inflation rising and borrowing costs squeezing households, Dales added, “you are easily at risk of a recession”.

Perhaps most perturbing of all for the UK is that its gilt yields are comfortably the highest among G7 economies. Yields are also elevated in the US, but the dollar’s reserve-currency status and the depth of its Treasury market provide a degree of insulation. In Germany, weaker growth and more subdued inflation are keeping a lid on yields. France and Italy carry higher debt burdens, but their yields are stabilised by the European Central Bank’s (ECB’s) policy framework (formalised through tools such as the Transmission Protection Instrument [TPI], which enables intervention to prevent excessive divergence in borrowing costs across member states). And Japan’s yields remain anchored by regular central-bank interventions.

Lacking those advantages, however, the UK remains more exposed, so bond investors demand higher risk premia, especially for holding longer-dated bonds. Indeed, the Bank of England (BoE) concluded in January that the primary driver of the increases in long-term interest rates last year was higher term premia—the compensation investors require for holding long-term bonds instead of a series of short-term bonds.

The UK also faces persistently higher inflation than either the US or the eurozone at present, despite being on a steady downward trajectory before the outbreak of the Iran War. With the closure of the Strait of Hormuz sending global energy prices skyrocketing, annual inflation rose to 3.3 percent in March from 3 percent in each of the previous two months.

Some analysts expect the BoE to struggle to contain inflation without resorting to raising interest rates. “There has been a material about-turn in the policy expectations for what the central bank might do,” Cosimo Codacci-Pisanelli, Goldman Sachs’ managing director in EMEA interest rate product sales at Global Banking & Markets, said in late March. “The Bank of England communication suggests that they prefer to err on the side of caution and tighten policy sooner rather than later in response to that energy price shock to keep inflation expectations in check.”

Since the start of the conflict, the BoE has held its benchmark Bank Rate at 3.75 percent at both its March 18 and April 30 meetings, but it also warned after the latter meeting that “higher inflation is unavoidable”. Having set out three scenarios for the economy, based on different paths for energy prices and second-round effects, moreover, the bank projected inflation to rise in all three cases, while unemployment would increase to at least 5.5 percent. And the worst-case scenario of a “more pronounced overshoot of inflation” was “likely to warrant a forceful tightening in monetary policy”.

What’s more, the BoE is no longer a net buyer of government bonds. Through quantitative tightening (QT), it has allowed its holdings to mature and run off and has also actively sold gilts, reducing its £895-billion pandemic-era peak holdings to around £529 billion by March 2026. It aims to trim its asset portfolio by £70 billion over the year to September 2026.

The combination of higher supply and lower demand creates downward pressure on bond prices, thereby sending yields higher.

QT removes a significant source of demand for gilts from the market. At the same time, government borrowing through the substantial issuance of gilts adds to market supply. The combination of higher supply and lower demand creates downward pressure on bond prices, thereby sending yields higher.

Uncertainty surrounding the Labour Party government’s fiscal strategy is also contributing to market caution, with investors reacting to the ambiguity encircling the trajectory of public finances. With a relatively high 98-percent debt-to-GDP ratio, ongoing pressure on public spending and limited fiscal space, any perception that fiscal discipline may weaken is likely to be reflected in higher yields.

With a leadership challenge to the increasingly unpopular Prime Minister Keir Starmer still a possibility for the time being, the market has seemingly priced in a consequential impact on fiscal policy. “A new prime minister would likely mean a new chancellor (finance minister). A new chancellor might mean new fiscal rules. And new fiscal rules would presumably herald more borrowing and gilt issuance, potentially complicating the Bank of England’s rate-cutting cycle,” ING contended. “UK yields likely go higher again if those risks resurface.”

Can anything be done to ease upward pressure on yields? A recent Barclays report advised the government to lower capital requirements for holding government debt to both increase the demand for gilts by £150 billion and lower the UK’s cost of borrowing by £2.5 billion annually. Specifically, Barclays suggested that demand for gilts could be increased by adjusting the way the bank leverage ratio—a calculation designed to be a risk-mitigating “backstop” to a bank’s prudential capital requirements—treats government bonds.

“We find that if those gilts that are not used as collateral for any trades (‘unencumbered’ gilts) were excluded from the denominator in the calculation of the leverage ratio—a plausible change given their substitutability for central bank reserves by banks’ treasury operations—then an order of magnitude estimate for the increased demand for UK gilts over time is around £150 billion,” the report noted.

“Based on a number of conservative assumptions using Office for Budget Responsibility and Bank of England estimates, this in turn could reduce gilt yields by up to 20 basis points at steady state, so reducing the amount of government spending required for debt servicing by an estimated £2.5 billion annually, all else being equal,” the report added. “From the point of view of HM Treasury, therefore, this figure then becomes available to spend on wider government priorities.”

What’s more, not everyone is currently bearish on UK government bonds. “The gilt market is penalising this government in a way that it wouldn’t have penalised, say, a Conservative government,” according to Invesco Asset Management strategist Paul Jackson, who told Bloomberg on April 23 that bond markets are being overly sensitive to the Labour government turmoil and that the UK is far from being the only country dealing with substantial debt. Jackson added that UK bonds are “reflecting the UK fiscal position more than, say, the US or France.”

It should also be noted that when the United Kingdom Debt Management Office (DMO) launched a £15-billion sale of a 10-year gilt with a gross redemption yield of 4.9158 percent on April 14, it was met with record orders worth a substantial ‌£148.2 billion. This demonstrates that UK government bonds are still attracting substantial investor interest, albeit when sufficiently compensated. “Wowser! Who said no one wanted to buy Gilts? Well… er, buyers bought because at 4.9 percent it’s a historically very attractive yield,” Bill Blain, chief executive officer of Windshift Capital, recently wrote in a Morning Porridge blog post.

Furthermore, a Reuters poll of 62 economists published on April 21 found that 14 expected at least one rate hike this year, while 15 projected one or more cuts. “The move we saw in the bond markets after the beginning of the ⁠war was already a great big tightening of monetary conditions,” said Laurence Mutkin, head of EMEA rates strategy at BMO Capital Markets. “And hopefully, that will be enough to keep inflation pressures low.”

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