U.K. bond markets rallied on Monday as former Chancellor of the Exchequer Rishi Sunak was handed the keys to Downing Street, but analysts cautioned that even under a government expected to be more austere, the calm may not last.
Holding steady from earlier, the yield on the 10-year gilt TMBMKGB-10Y, 3.711% fell 23 basis points to 3.82%, that of the 30-year gilt TMBMKGB-30Y, 3.736% dropped 18 basis points to 3.88%, while the 2-year gilt TMBMKGB-02Y, 3.295% fell 24 basis points to 3.42%. Yields move in the opposite direction to prices.
The pound GBPUSD, +0.06% was weaker, down 0.8% to $1,1282, but having still recovered ground from a low of $1.1061 on Friday. News that Sunak won the Conservative Party leadership contest had largely been priced in earlier, with news that former Prime Minister Boris Johnson had bowed out also helping.
“Sunak is seen as having a safer pair of hands than his predecessor, with his constant warnings about the disastrous consequences of Liz Truss’s economic policies being proven correct,” said Nigel Green, chief executive officer of deVere Group.
“However, we expect the current relief rally of the markets will be over sooner rather than later because the U.K. still faces a storm of economic problems. There’s the brewing deep and painful recession, soaring energy price, inflation running at more than 10%, labor gaps, ongoing supply chain dramas, and the Bank of England intent on hiking interest rates,” Green said in a note.
Investors were greeted by sour data on Monday, with the S&P Global/Cips flash UK composite output index for October falling to a 21-month low, the third such sub-50 reading, meaning many companies are seeing a contraction in activity.
Analysts say Sunak and current chancellor, Jeremy Hunt, who is expected to stay in that post, will likely present a united front of pinching pennies, even ahead of the tough winter facing the U.K. and Europe that have seen energy prices soar as a consequence of Russia’s monthslong war in Ukraine.
“This isn’t the same Rishi Sunak who gave Santa a run for his money during the pandemic. He’s going to have an incredibly tight hold on the purse strings. Jeremy Hunt is likely to stay at Number 11 with his mantra of tough decisions and spending cuts. It means we may not be able to rely on extra help when we’re facing horrific price rises next April,” said Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, in a note to clients.
Global investors, though, will be keeping a wary eye on any bumps for bonds. U.K. politics upended global financial markets weeks ago after Truss, who announced her resignation last week, alongside her ex-chancellor Kwasi Kwarteng announced a budget laden with unfunded tax cuts, That triggered a bond rout and sinking pound, and also for a time bled into other markets such as Wall Street.
Much like Monday’s developments, her resignation also offered some respite for U.K. bonds and the pound.
“Markets had largely priced in a Sunak victory first thing this morning after Boris Johnson exited the race yesterday…Mr Sunak and his Chancellor will have to earn any further market rallies,” said Philip Shaw, chief economist at Investec, in a note to clients.
Markets have also benefited from the calm provided by the Bank of England’s emergency bond buying program. It’s planning to start selling gilts on Nov. 1, just as a Federal Open Market Committee meeting gets underway.
The Fed is expected to increase interest rates 75 basis points, while the European Central Bank is expected to do the same this Thursday. The Bank of England also meets next week, with Investec’s Shaw among those expecting another 75 basis point hike.