Recent fall in gilt yields could prove short lived

We think that the recent fall in gilt yields – which appears to partly reflect lower Bank Rate expectations – has been overdone. While economic data has taken a slight turn for the worse, we remain confident that the economy will continue to hold up fairly well and that GDP growth will surprise the consensus on the upside. This would allow the MPC to start normalising interest rates earlier, and at a faster rate, than markets currently anticipate – pushing up gilt yields. What’s more, we think that inflation will rise to a higher rate than currently priced into markets. We also believe that the impending end of the Bank of England’s gilt buying scheme and rises in US Treasury yields could put upward pressure on gilt yields. Overall, we forecast that 10-year gilt yields will rise to around 1.75% by the end of 2017 and reach about 2.0% at the end of 2018.