Over the last two months, yields on UK and US government bonds have decoupled, with 10-year yields in the UK now about 30bp lower than those across the Atlantic. Whereas strong US economic data and less dovish language in the FOMC’s most recent statement have pushed up expectations for US interest rates, the sharp fall in UK inflation has led markets to expect Bank Rate to hold steady throughout 2015. Although we think that the first UK rate hike may come a little sooner, markets are surely right to expect a slower pace of monetary tightening than in the US ahead. Debt levels in the UK are still much higher than in the US, and the former faces a more substantial fiscal squeeze. Accordingly, by the end of next year, we think that the gap between UK and US yields is likely to have widened further, with 10-year bonds yielding about 3% and 3.75% respectively.
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