Broken ceasefire pushes cost of UK government borrowing higher

Against this backdrop, the UK’s new Prime Minister, Andy Burnham, faces the challenge of balancing fiscal ambitions with increasingly nervous bond holders. UK gilt yields rose sharply during July as investors priced in the risks associated with further disruptions to oil supplies through the Strait of Hormuz. Yields were further pressured by concerns over Burnham’s willingness to adopt a more flexible approach to fiscal rules alongside a planned cost of living support package.

The Bank of England (BoE) voted to keep the bank rate unchanged, continuing with their wait-and-see approach. Markets are pricing in just a 30% probability of a rate rise this year following central bank guidance that rates are unlikely to increase in the near term. Nevertheless, the BoE expects CPI inflation to rise from its current rate of 2.6% to above 3% by year-end before gradually returning towards its 2% target.

In the US, Treasury yields reached a 19-year high after the Federal Reserve also left interest rates unchanged. Recent data showed US economic growth slowing from an annualised 2.1% in the first quarter to 1.5% in the second quarter. By contrast, the Eurozone economy expanded by 0.4% in the second quarter, with the European Central Bank also maintaining lending rates at current levels as Eurozone inflation hit 2.9% in July.

Japan has experienced a similar mix of pressures during the month. Concerns of a global oil shock, combined with Prime Minister Sanae Takaichi’s longterm $2tn spending programme, pushed the Yen to a 40-year low and Japanese government bond yields to their highest level in three decades. In response, the US Treasury intervened by selling Euros to purchase Yen to prop up the Japanese currency, indirectly protecting the US from higher borrowing costs.

In equity markets, confidence in the “Magnificent Seven” has weakened amid concerns over whether substantial artificial intelligence investment will translate into adequate profits. As a result, global equities declined over July.

UK equities proved more resilient at least with a lack of exposure to a volatile tech sector. Emerging markets experienced particularly sharp swings, with South Korea’s tech heavy KOSPI Index falling 22% over the month despite recovering 18% into month end. Fixed interest and index-linked gilts both delivered negative returns over the month, while corporate bond spreads remained tight.

On a low-risk basis, the aggregate funding level of UK defined benefit pension schemes improved modestly over July. Higher gilt yields, driven by the sell-off in government bonds, were somewhat offset by weaker growth asset performance.