Concerns among investors regarding the economic outlook of the United Kingdom are intensifying, with long-term ​Bonds yields in the UK rising to a 26-year high.

On Friday, December 20, Eastern Time, the yield on 30-year UK Bonds rose for the seventh consecutive trading day, reaching as high as 5.16%, the highest level in 26 years.

In just one week, market bets on the number of interest rate cuts by the Bank of England next year experienced multiple reversals. The market shifted from betting on four rate cuts to betting on less than two, and then to betting on three cuts:

On Monday, the market bet on four rate cuts by the Bank of England next year, totaling over 70 basis points.

On Wednesday, driven by rising RBOB Gasoline prices, UK inflation rose to an eight-month high, with the November CPI increasing by 2.6% year-on-year, exceeding the Bank's 2% target. This intensified concerns over stagflation with high inflation and low growth coexisting, while rental prices in London also hit record highs. The UK faces inflation risks both domestically and internationally, leading the market to reduce its bets on rate cuts, expecting that the Bank of England will keep interest rates unchanged at 4.75% this Thursday, and is projected to cautiously cut by 49 basis points next year. Morgan Stanley anticipates that the Bank of England will not begin cutting rates until February 2025.

On Thursday, the Bank of England did not cut rates as expected, and inflation is likely to continue rising in the short term. However, there are significant internal divisions, with three officials calling for a 25 basis point cut, and a third of committee members voting in favor of a cut, which exceeded market expectations. Bank of England Governor Andrew Bailey stated that due to "the high uncertainty of the economy," he "cannot commit to when or how much the cut would be." This division and uncertainty further intensified market volatility. Traders increased their bets on rate cuts, expecting the Bank of England to cut rates three times next year by a total of 61 basis points, greater than the previously anticipated less than 50 basis points.

The fundamental reasons behind the market volatility include: first, the uncertain economic outlook for the UK, with inflation pressures existing alongside weak economic growth, complicating policy prediction. Second, there are divisions within the Bank of England regarding rate cuts, making it difficult for the market to accurately forecast future interest rate trends. Third, the UK government's borrowing this year may exceed official forecasts, increasing the risk that the government may need to secure further financing early next year, with a potential increase in the supply of UK government Bonds becoming a new adverse factor.

Ed Hutchings, head of interest rates at Aviva Investors, pointed out that 2025 will be a key year for the issuance and yield adjustments in the UK bond market.

The economic situation of the Bank of England is complex, and internal divisions within the central bank are intensifying.

The UK economy is currently showing mixed signals. The latest business survey from the Bank of England reveals a weak labor market, yet wage growth is exceeding expectations. This contradictory economic situation, coupled with the fiscal stimulus plan announced in October and the global spillover effects from USA policies, is making decision-making at the Bank of England even more challenging.

Investors are worried about the UK economic outlook. According to the Bloomberg Index, a typical UK government bond portfolio has dropped over 4% this year. In contrast, Eurozone government bonds have returned 2% during the same period, while the USA government bond benchmark index is basically flat. Matthew Ryan, head of Ebury market strategy, stated:

"Bank of England officials seem to have greater division on the future interest rate path than ever before, reflecting the complex outlook for the UK economy, with weak consumer demand being offset by the inflation impact of the autumn budget and Trump’s tariff proposals."

Despite facing numerous uncertainties, there are also opportunities. If inflationary pressures in the UK ease in 2025, as many economists expect, the Bank of England may cut rates more aggressively, leading to a rebound in the bond market.

Guy Stear, head of Developed Markets strategy at Amundi Investment Research, believes:

"The three members currently voting in favor of rate cuts may be right, as the risk lies with the six members who are voting to maintain rates, being too focused on the recently higher-than-expected inflation data, without adequately considering the weak growth data. We think the Bank of England could cut rates up to five times next year."

However, the long positions on UK Bonds have been disappointed this year. At the beginning of 2024, the market expected the Bank of England to cut interest rates by about 150 basis points throughout the year. But in reality, the Bank of England only lowered rates by 50 basis points, which is less than the Federal Reserve and the European Central Bank.

Susannah Streeter, the head of MMF and markets at Hargreaves Lansdown, stated:

"We are still on the path of lowering interest rates, but the harsh economic environment means we have to slow down our pace."