UK government borrowing costs hit record low as markets start to price in stronger chance of interest rate cut

Chris Papadopoullos
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Chancellor of the Exchequer George Osborne Leaves Downing Street
The fall in borrowing costs could give chancellor George Osborne more cash to play with in the March budget (Source: Getty)

UK government borrowing costs have fallen to record lows as investors ditch risky stocks and flock to the safety of the bond market.

The interest on a 10-year UK government bond dropped to 1.275 per cent today. It was just shy of two per cent at the turn of the year and nearly a full percentage point below its 2015 peak. A one percentage point drop in government bond yields translates roughly to a saving of £4.4bn over the current parliament, according to Office for Budget Responsibility's debt interest ready reckoner.

Market expectations of Bank of England interest rates, as gauged by so called overnight index swap rates, suggest markets now believe there is a stronger chance of an interest cut this year rather than a hike.

Bank of England governor Mark Carney maintained that the next move in interest rates would likely be upward at the Bank’s inflation report last week. However, the Bank’s monetary policy committee voted unanimously to hold interest rates for the first time since the summer.

"There has been a dramatic shift in rate expectations at the shorter end of the yield curve, with a cut actually now deemed more likely than a hike this year, and a full hike not priced in for more than two years," said economist David Tinsley from UBS.

"This is starkly at odds with the Bank of England's view, with the February Inflation Report forecast for CPI at the three-year horizon well above the 2.0% target. A significant reversal of the rally is unlikely for now, though if the vote is ultimately for the UK to remain in the EU, we expect a swift correction thereafter as the MPC is likely to sound more determined than it does now to get moving on the tightening path."

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