Yields on two-year gilts climbed to the highest level since 2008 as strong labour market figures drove expectations that UK interest rates would stay higher for longer.
Figures showed that regular pay growth was 7.2 per cent between February and April this year – the highest growth rate seen outside of the pandemic. Unemployment remains low at 3.8 per cent, while vacancies fell.
Following the release, Barret Kupelian, senior economist at PwC, said the "abnormally hot labour market" meant the Bank of England would have to "raise and keep interest rates longer to a level higher than anticipated”. Markets now expect policymakers to increase interest rates by more than one percentage point to a peak of over 5.5 per cent by the end of the year.
Interest-rate-sensitive two-year gilts sold off on Tuesday, and yields rose by 0.25 percentage points to 4.89 per cent. This was higher than the levels seen during the bond market turmoil that followed Truss’s “mini” Budget. However, in contrast to September, yields on 10-year gilts (which are less sensitive to interest rate expectations) saw limited movement this time around, rising 0.11 percentage points to 4.46 per cent.
The gilt market reaction was followed on Wednesday by data showing that UK GDP rose by 0.2 per cent in April, after a fall of 0.3 per cent in March. However, markets are back into 'good news is bad news' territory. Kitty Ussher, chief economist at the Institute of Directors, said that though growth would be encouraging for consumer-facing sectors, it strengthen the case for more rate hikes.
“The Bank of England may interpret it as proof that their interest rate hikes have not yet dampened demand enough to reduce inflationary pressure, particularly when combined with yesterday’s strong labour market performance”, she said.
