Who lost the UK bond market?
The volatility of gilts is a big problem for the country and must be tackled
Mohamed El-Erian
In the Agatha Christie novels I read growing up, the denouement of Murder on the Orient Express stands out for its wide distribution of guilt: everyone held the dagger.
As one considers the volatility of the UK bond market, central to the country’s economic and financial wellbeing, the parallels are striking.
The UK sovereign debt market has gone from a bedrock of the economy to a temperamental asset class that overreacts at the slightest provocation, both on a standalone basis and relative to other government bond markets.
The additional yield on UK 10-year Gilts compared with their German counterpart increased from around 1.65 percentage points just before the war to an intraday peak of 1.95 points when the yield surpassed 5 per cent.
The spread with the US widened from 0.34 percentage points to 0.61 points during the same period.
The daily volatility was also more pronounced.
In Murder on the Orient Express, few shed tears for the victim.
The UK gilt market is different.
If it continues to struggle, this will be felt by many, including young families priced out of homes not just by higher mortgage rates but also by the unstable availability of loan products.
For the government, the diminution of the market’s “safe asset” status means a relentless, exhausting race to service interest costs raised by a risk premium that partly reflects increased volatility.
This is happening at a bad moment: a time when public services are stretched, the tax burden is at a multi-decade high, and the fiscal “headroom” has shrunk.
For the corporate sector, the “high-beta” nature of the UK market — where British yields move significantly more than their American or European counterparts — creates a less predictable cost of capital.
And at the very moment when the UK stands on the cusp of productivity-enhancing innovations in AI and green tech, the financial system struggles to deliver the necessary risk capital to the scale-up firms that Britain needs without a stable bond market as an anchor.
How did a market once defined by stability change so much?
To ask who’s responsible for this is to find a room full of suspects.
First, the external environment has been exceptionally cruel.
Most recently, the US-Israeli war with Iran has fuelled inflation higher and pushed bond investors to demand higher compensation for holding debt.
Second, successive governments need to ask themselves some hard questions.
For over a decade, the UK has failed the basic test of debt sustainability: borrowing too much while growing too little.
This imbalance created a tinderbox, waiting for a spark.
That spark arrived in September 2022 with the budget crisis in the Liz Truss government that exposed the structural vulnerabilities of the UK’s financial system.
Public opinion sometimes casts the Bank of England as the villain, accusing it of being too eager to raise interest rates.
But that’s unfair.
Despite popular misunderstandings, the BoE has been a model of policy responsiveness and crisis management.
Fixing the gilt market is not merely a technical exercise; it is a prerequisite for national prosperity.
If the UK wishes to escape the trap of insufficient growth, low productivity and fiscal fragility, it must restore the market’s anchoring role.
Crucially, that must be underpinned by continued fiscal and monetary discipline.
Trust is earned in drops and lost in buckets; the UK is currently in the slow process of refilling that bucket.
There also needs to be work done to foster a domestic financial system deep enough to support the scale-up of British firms.
The banking system must improve as an essential pressure-release valve by strengthening the short-term funding market and more broadly boosting frameworks on access to liquidity during disruptions — measures that the Prudential Regulation Authority is now consulting on.
By ensuring banks are operationally ready to access central bank facilities and maintaining countercyclical capital buffers, the system can better absorb shocks rather than worsen them.
This should be backed by incentives to gradually diversify the investor base in gilts and pension fund reforms that nudge asset allocation choices away from volatile and excessively narrow strategies, including poorly designed liability-driven investments.
Through a combination of many years of external shocks, low growth, fiscal slippages and an insufficiently responsive financial system, the UK government bond market has lost its composure.
We also know the way out: the long, crucial task of boosting productivity, maintaining macro stability, and bolstering institutional strength.
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