Jack Wellard, a research economist with RSM UK, contributed to this article.
While government bond yields have risen across advanced economies in response to the jump in energy prices, the move has been notably more pronounced in the UK.
Gilts have underperformed their U.S. and European counterparts, with short-dated yields in particular seeing some of the largest increases in the Group of Seven.
This divergence is not accidental. It reflects a combination of structural vulnerabilities in the UK economy, policy dynamics and market-specific features that amplify global shocks. There are three key factors at play.
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Inflation
First, the UK is likely to face a more acute inflation shock. The UK’s reliance on gas means that wholesale price increases pass through more fully to households and firms. As a result, markets have reassessed the UK inflation outlook more aggressively than elsewhere.
There is also a credibility angle. Investors remain wary that UK inflation is more prone to second-round effects, particularly via wages as UK employees were able to better protect their real wages during 2022 and 2023 than in Europe, meaning inflation expectations are less firmly anchored.
Rate expectations
Second, the energy price shock has led to a bigger repricing of interest rate expectations than elsewhere. Rate expectations have risen by 60 basis points in the UK, compared to 50 basis points in Europe and 40 in the U.S.
This repricing has been especially visible at the front end of the curve. Two-year gilt yields have surged by significantly more than their U.S. or German equivalents, reflecting a more abrupt change in monetary policy expectations.
Weaker growth
Third, the UK economy provides a weaker economic backdrop. The combination of weak trend growth and still-elevated inflation and inflation expectations makes the UK look more vulnerable to the international investors the UK is now reliant on for borrowing.
There are also concerns about fiscal space. With limited headroom in the public finances, markets worry that any government response to cushion households from higher energy prices could worsen borrowing dynamics.
What’s more, there is still a clear element of political risk in the UK that is amplifying concerns.
Betting markets show an almost 50% chance that Keir Starmer will no longer be prime minister by the end of June and a 70% chance by the end of the year. That raises the risks that UK fiscal policy will become looser in the future, necessitating more borrowing.
Of course, if there is a swift resolution to the crisis and energy prices fall back, gilt yields will drop rapidly. But the Iran war has highlighted that the UK and its fiscal position are more vulnerable to shocks than many comparable countries.
