Gilts sell off and inflation complicate Bank of England's rate cuts

The Labour government's complete turnaround on increasing income tax rates brought renewed nervousness to the UK bond market last week. Bonds sold off all day on Friday after the announcement, and the UK is once again leading the latest leg in the upward move of rates in G10 countries. UK stocks also underperformed amid fears over the government’s credibility, a possible breaking of Labour’s self-imposed fiscal rules and uncertainty as to how Chancellor Reeves will now plug the gaping hole in the public coffers.

Labour market data for September and October published last week confirmed the weakening trend in the jobs market, as unemployment ticked up and businesses continued to shed workers. Soft GDP figures capped a grim week for the UK and the pound, which has lagged behind every currency in the G10 save the yen in the past month. The sell off in the gilt market and stubbornly high inflation complicate what would otherwise be the Bank of England's obvious response to softening data: cutting rates.