A trip to the IMF? We have had a hot summer but this is not 1976….

While some media headlines about the UK’s high long-term borrowing costs may be somewhat sensational, there have been significant moves in gilt yields at the long end reflecting market concern about inflation and borrowing. W1M’s James Carter wrote last month answering the question: Is the UK Bankrupt?. Given recent headlines, it is worth revisiting some of the facts.

The UK turning to the IMF in 1976 was in the context of the UK running large external deficits while inflation was out of control at around 25%, compared to below 4% now and falling. UK government borrowing then was heavily denominated in currencies other than sterling but does not carry that foreign currency risk today. The UK domestic bond market is liquid and functioning.

UK 20yr gilt real yield (vs 20yr CPI swaps)

UK gilt auctions – bid-to-cover ratio

Source: Bloomberg, UK Debt Management Office, W1M. data as at 29 August 2025

Context matters, always. UK gilts may have underperformed US treasuries but both have fallen with other bonds as global inflation rose post the ending of pandemic lockdowns. So, higher gilt yields are not something as surprising or a sudden phenomenon as they were in the Liz Truss interlude. But, there is no getting away from the fact that the markets are concerned both about inflation appearing more stubborn in the UK and the government’s attempts to rein in welfare spending failing in parliament, leaving the Treasury with a greater borrowing requirement and the need to increase taxes. Having said that, UK growth is not collapsing, inflation and interest rates are set to fall on a 12-18 month view and while there is a fiscal deficit, unless government tax and spending “ironclad” objectives are dropped, that deficit is smaller than the US fiscal deficit in percentage terms and is also set to fall gradually. Challenges exist for the UK in improving its growth rate, productivity, participation rates in the labour market and fiscal position, but it is not a weak outlier relative to its major European peers nor the US.

Real government bond yields - G7 + Australia

Source: Bloomberg, Japan Cabinet Office, Minack advisors, W1M. data as at 29 August 2025. 

If the UK fiscal position is not exceptional relative to the G7 and panicking headlines don’t seem appropriate, are gilt yields maybe attractive now that so many negative headlines have appeared? James Carter points out that while the US market prices in 5 to 6 interest rate cuts in the next 18 months, the UK is only expected to see one cut and to end up with a higher interest rate than the US; that seems a very pessimistic view, particularly with the UK likely to see weaker growth than the more dynamic US economy and less (tariff and migration policy related) inflationary pressure too. UK gilts could enjoy some appreciation if the Bank of England feels able to cut rates more aggressively than currently expected.

W1 M’s Matthew Farrell writing about US debt issues has pointed out that “It doesn't matter - until it does”. US markets know about the negative US fiscal position and core CPI being around 3% while the Fed is under pressure to cut interest rates; at this time, the are not overly concerned. UK long gilt yields being relatively high are not really a great global issue today; a bigger problem for global markets would be the US bond market changing to take a bearish view on US inflation prospects. Concerns about US inflation could easily increase given tariffs tend to drive up prices and a currently popular, tough US immigration policy is exacerbating US labour market shortages and driving up wages. But those things don’t matter until they do.

US-debt/GDP vs. 10-year real treasury yield & term premium

Source: US Treasury, CBO, New York Fed, Macrobond

Conclusion:

• While W1M remains slightly underweight fixed income, we retain a preference for government bonds, including gilts, relative to credit given relative valuations.
• As mentioned above, UK debt to GDP, deficits and bond yields are not radically out of line with peers so we see no need to panic.
• We hold UK government bonds in our multi asset solutions for diversification and risk control reasons but also see potential for UK rates to fall more than expected in the next 18 months, giving gilts potential upside.
• We are less keen on Japanese government bonds (JGBs) as inflation there is around 3.5% while their year JGB ten year yield is only 1.6%; that means JGBs have downside potential if their yields need to rise.
• We are positive on Australian government bonds as it has a debt to GDP ratio of around only 55%, just a 1% fiscal deficit, inflation there is under control and their central bank has been slow to cut rates; this means Australian short end yields have the potential to fall - there is upside, in our view.
• The situation today is very different to 1976; headlines about the UK (or France) going to the IMF seem premature.