UK government bonds slide

(Sharecast News) - Ten-year gilts rose to levels not seen since 2008 on Monday, as traders reversed previously-held forecasts and priced in four interest rate hikes this year. Fears are mounting that the conflict in the Middle East, which shows little sign of easing, will lead to prolonged global economic shock, including soaring energy prices and resurgent inflation.

At the start of 2026, it was widely accepted that the Bank of England would continue cutting the cost of borrowing, as it sought to boost economic growth as inflationary pressures waned. Most analysts had forecast the first cut to be announced at the Monetary Policy Committee's March meeting.

However, following the outbreak of war and the ensuing spike in gas and energy prices, the central bank opted to leave Bank Rate at 3.75% last week. It also confirmed it "stands ready" to tackle any spike in inflation.

By mid-morning on Monday, interest rate futures were pricing in around four rate rises this year. Prior to the conflict beginning at the start of March, traders in the swaps market had been expecting two cuts this year.

As a result, 10-year UK government bond yields rose to 5.079%, their highest level since 2008, while prices fell. Yields move inversely to prices in bond trading.

Government bonds also fell across Europe. British debt was hit particularly hard, however, as the UK depends on imported energy, meaning higher global oil and gas prices can feed more quickly through to inflation.

Rabobank said: "Since the start of the conflict, sterling has lost ground versus the dollar, Norwegian krone and Canadian dollar. These are all currencies of energy-exporting countries.

"The UK economy is showing signs of a loosening in the labour market and an increase in spare capacity, meaning that it is more vulnerable to the stagflationary impact of higher energy prices.

"The UK is not the only country with a high debt/GDP ratio. However, as was demonstrated by the Truss mini budget in September 2022, the combination of a large debt and a current account deficit suggest that a country's bond market is more susceptible to suffering market jitters."

On Friday, Donald Trump insisted the war was "winding down". But 24 hours later he threatened to attack Iran's infrastructure if it did not reopen the Strait of Hormuz by the start of this week. Tehran responded by saying it would target critical infrastructure across the region, sending oil prices soaring and equities tumbling.

Russ Mould, investment director at AJ Bell, said: "So far during the current crisis, investors have focused on the potential for a short, sharp inflationary shock. That's an uncomfortable situation but not out of the ordinary.

"Now the focus shifts to a more serious scenario.

"Three weeks ago the market expected two rate cuts in the UK this year. We're now looking at a situation where rates could be hiked four times, according to market probability data. This has significant consequences for consumer and business spending, and for public finances as the government's cost of servicing debt would go up and tighten fiscal headroom."