Gilts: Iran Shock Kills the Rate-Cut Dream

The repricing has been violent by gilt market standards. UK 10-year yields surged from roughly 4.23% in late February to 4.92% by March 27 — a 69 basis point move in four weeks. The 20-year hit 5.55%. The 30-year reached 5.61%. These are levels that recall the September 2022 pension fund crisis, though the cause this time is geopolitical rather than fiscal.

US Treasuries have moved in sympathy but from a lower base. The 10-year Treasury climbed from 4.21% on March 11 to 4.42% by March 26. The 2-year reached 3.96%. The US yield curve spread stands at 0.56%, steepening as markets reprice growth risk alongside inflation.

The UK-US spread has blown out to roughly 50 basis points — up from 30bp before the conflict. That premium reflects three UK-specific risks: worse inflation arithmetic, weaker fiscal headroom, and a larger stock of inflation-linked debt that mechanically increases borrowing costs when prices rise.

The unanimity of the March vote carries more weight than the decision itself. Sarah Breeden and Swati Dhingra — the MPC's most dovish voices — abandoned their rate-cut stance in a single meeting. That doesn't happen unless the Committee sees a genuinely different risk landscape.

The BoE's preliminary estimates released alongside the decision project CPI between 3.0% and 3.5% over the next two quarters, driven by higher energy costs feeding through to household bills. Core inflation at 3.1% has barely moved. Services inflation — the MPC's preferred gauge of domestic price pressure — remains stubbornly elevated.

Contrast with the Federal Reserve. The Fed funds rate at 3.64% sits below the BoE's 3.75%, a reversal of the typical hierarchy. The Fed cut six times from 4.33% since mid-2025; the BoE managed four. America's energy self-sufficiency gives the Fed more room to look through temporary price spikes. The BoE has no such luxury — the UK imports 40% of its gas and every penny of the price increase transmits directly to household bills and business costs.

Markets now price the next BoE cut no earlier than Q3 2026. Some forecasters have started discussing the previously unthinkable: a rate hike if CPI reaccelerates above 4%.

The Iran conflict hits UK bonds harder than US Treasuries because of how energy costs flow through the British economy.

UK wholesale gas prices surging 40% translates directly into Ofgem's quarterly energy price cap. Households already stretched by the 2022 energy crisis face another round of bill increases starting in Q2. That feeds into services inflation — the stickiest component — through higher operating costs for everything from restaurants to care homes.

Mortgage rates respond to gilt yields, not the base rate. The 5-year gilt yield drives fixed-rate mortgage pricing, and every 25 basis points added means roughly £50 more per month on a £250,000 remortgage. With 1.6 million UK homeowners facing remortgaging in 2026, the gilt sell-off is a direct hit to consumer spending.

The BBC is already comparing the current situation to the 1970s oil crisis. The parallel isn't perfect — the UK economy is less manufacturing-dependent today — but the mechanism is the same: an external energy shock that monetary policy cannot offset without crushing domestic demand.

China suppliers are warning of higher prices for Americans due to Strait of Hormuz closure, adding a trade disruption layer on top of the energy cost spike. Global supply chains are repricing risk simultaneously.

The February bond rally now looks like a false dawn. Global 10-year yields fell broadly that month — US Treasuries dropped nearly 30bp, UK gilts fell a similar amount. March has reversed all of it and then some.

The divergence is between central banks that can absorb the shock and those that cannot. The ECB, with eurozone inflation near target, retains room to cut. The Fed, with domestic energy production, can tolerate temporary price pressures. The BoE has neither advantage.

The UK's fiscal position amplifies the vulnerability. Gilt issuance for 2026-27 requires over £250 billion in gross financing. The DMO is selling into a market where 10-year yields just hit an 18-year high. The government's £9.9 billion fiscal headroom — already razor-thin — has likely been wiped out by higher borrowing costs. Every 25bp rise across the curve adds £6-7 billion to annual debt servicing.

Foreign demand for gilts has been weakening. China and Japan have reduced sterling-denominated holdings, leaving domestic pension funds and insurers as the marginal buyers. Those buyers are price-sensitive and have been forced sellers at times during the current volatility — a destabilising feedback loop.