UK gilts still a good bet, says world’s largest bond fund

The world’s largest bond fund has said that UK government debt remains an attractive bet for investors, praised Labour’s budget plans and warned against predicting a rise in inflation.
Pimco, a giant global bond fund that owns UK bonds, said investor fears about the government’s borrowing plans and the threat of rising inflation had been overdone.
“We see no reason to question the government’s fiscal credibility,” Peder Beck-Friis, economist at Pimco, said. “They intend to bring the primary balance into surplus. The important point is that fiscal policy will remain tight in future years with the deficit going from 4.5 per cent to 2 per cent of GDP.”
Gilt yields, which move inversely to bond prices, crept up again on Friday morning by 5 basis points to 4.47 per cent on 10-year bonds. Borrowing costs have climbed to a 12-month high after the budget, the 10-year yield peaking at 4.55 per cent on Thursday before trading lower.
Bond yields in France, Germany and the US also rose in Friday morning trading, with gilts underperforming peers.
The Bank of England will give its first response to the government’s £70 billion spending plans when it makes its latest interest rate decision next week. Ratesetters are widely expected to cut the base rate from 5 per cent to 4.75 per cent, the second monetary loosening this the year.
The monetary policy committee (MPC) will also produce new inflation and growth forecasts for the economy over the next three years that will be closely watched by economists. Analysts at Nomura said the committee would lower its inflation and growth forecasts after price growth fell to 1.7 per cent, below its 2 per cent target, in September.
• What is happening in the gilt market — and should we be worried?
The bulk of this week’s bond selling has been concentrated on shorter-dated gilts, which are more exposed to interest rate changes. The yield on the two-year gilt has risen from 4.2 per cent at the start of the week to 4.45 per cent: a five-month high.
Shorter-dated bonds have suffered as investors are anticipating one, rather than two, interest rate cuts from the Bank of England before the end of the year over fears that Labour’s front-loaded spending and borrowing plans could temporarily reignite inflation.
The Office for Budget Responsibility said Labour’s policies would raise average inflation by 0.6 percentage points next year and inflation would sustainably fall to the Bank’s 2 per cent target only in 2029.
Beck-Friis said the MPC would not be forced to change course after the budget as inflation and growth remained weak. “We don’t think the budget changes the Bank of England’s outlook meaningfully,” he said. “With the budget behind us, the market will shift focus from fiscal policy back to the macro backdrop and back to inflation softening and the labour market cooling down.
“We expect the Bank to cut next week and remain data-dependent going forward. The market’s terminal interest rate forecast of around 4 per cent looks high relative to what we think is the neutral rate of interest in the UK. We find gilts attractive at these levels.
“It is possible that the budget might add to near-term demand but this is small given the overall growth outlook. The fundamental outlook is still one of tightening fiscal policy and loosening labour market conditions.”