The Gilt market under pressure

An analysis of the forces driving UK borrowing costs to multi-decade highs and what it would take to bring them back down.

I. Root causes: a triple shock

The UK gilt market has been subjected to a rare and damaging convergence of three distinct pressures since early March 2026: an external energy shock, a domestic inflation problem that refuses to abate, and a political crisis that has affected investor confidence in the UK's fiscal trajectory. Individually, each would be manageable. Together, they have driven 10-year gilt yields to 5.17% and 30-year yields to 5.86%, levels not seen since 2008 and 1998 respectively.

The proximate trigger was the Middle East conflict and the effective closure of the Strait of Hormuz. The energy shock fed directly into UK inflation expectations, with swaps markets pricing in 75 basis points of Bank of England rate hikes by year-end at the peak of the crisis. UK CPI, already running at 3.3% in March, well above the Bank's 2% target, is expected to exceed 3.5% towards the end of 2026 as energy costs feed through.

Layered on top of the energy shock was a domestic political crisis. Labour's weak performance in the May 7 local elections triggered a rebellion within the parliamentary party, with over 80 MPs calling on Prime Minister Keir Starmer to resign. Three junior ministers resigned in quick succession, and by mid-May, both Wes Streeting and Andy Burnham had publicly positioned themselves as leadership candidates. The gilt market's reaction was swift: political instability raised the possibility of a successor willing to loosen fiscal policy, a scenario bond investors fear most.

II. Gilt-Bund spreads since the start of the war

The divergence between UK gilts and German Bunds since the outbreak of the Middle East conflict in early March 2026 is stark. At the 10-year point, the spread widened from 166 basis points on March 2 to 200 basis points by May 12. The widening reflects shared global factors, as rising oil prices affect all European bond markets, alongside a UK-specific premium that has been building steadily.

Source: Bloomberg, DPAM, 2026

The divergence is explained by the UK's particular vulnerability to the energy shock, discussed below, compounded by domestic political risk that currently has no equivalent in Germany. While Bund yields have also risen, with the 10-year Bund moving from 2.64% to 3.16% over the same period, the move in gilts has been materially larger in both absolute and relative terms. Gilts remain the clear underperformer, caught between the dual pressures of global energy-driven inflation risk and intensifying domestic political instability.

III. The ghost of Liz Truss: how does this compare?

Comparisons with the September 2022 Truss mini-Budget episode are inevitable, though the dynamics differ in important ways.

During the Truss episode, the 10-year gilt yield surged from approximately 3.10% on September 22, 2022 , the day of the mini-Budget, to a peak of 4.51% on September 27, a move of 140 basis points in five trading days. The UK-Germany 10-year spread widened from 153 basis points to 228 basis points at its peak on September 27, before falling back to around 140 basis points within weeks once Truss reversed course and eventually resigned. The Bank of England was forced to intervene with emergency gilt purchases to prevent a collapse in the liability-driven investment (LDI) pension fund sector.

The current episode differs in character. The Truss shock was a sudden, self-inflicted fiscal credibility crisis, a single event with a clear cause and resolution through the reversal of the mini-Budget. The current situation is a slow-burning, multi-factor deterioration. The 10-year gilt yield has risen by almost 100 basis points since early March 2026, a more gradual but potentially more durable move. Crucially, there is no single policy reversal that can resolve it.

The Bank of England has a financial stability mandate and could intervene if gilt yield moves appear excessive, as it did in autumn 2022 due to concerns over fiscal irresponsibility and excessive leverage in the UK pension system. Excessive volatility in UK government bonds could lead the Bank of England to pause gilt sales under its quantitative tightening programme, potentially moving from active sales to passive roll-off at the September review period.

One important parallel with 2022 is the role of overseas investors. About a third of the government's gilts are held by overseas investors, who can easily shift money elsewhere during a crisis.

Britain risks a Truss-style bond market meltdown should any replacement for Starmer row back on the government's spending and borrowing commitments.

IV. The political landscape: scenarios and their gilt implications

As of May 17, 2026, the UK political situation remains fluid. Wes Streeting has officially announced his intention to challenge Starmer, while Andy Burnham has been cleared to stand in the Makerfield by-election, giving him a potential path back to Westminster. The market must now price in a range of scenarios:

Starmer survives. The base case for gilt stability. Starmer's fiscal framework remains intact. Gilt yields would likely retrace some of the political risk premium, though the energy and inflation component would persist.

Wes Streeting becomes Prime Minister. Streeting would likely be perceived as broadly continuing the current fiscal framework, which markets may view as reassuring.

Andy Burnham becomes Prime Minister. Burnham could be perceived by markets as less tightly aligned with existing fiscal orthodoxies, introducing some uncertainty. A Burnham victory would likely trigger a further sell-off.

A left-leaning candidate from the Tribune Group. A shift towards a more expansionary fiscal framework could widen yields and increase volatility, though outcomes would depend heavily on the specifics of policy.

V. Why the UK is more sensitive to inflation than its peers

Every major economy is grappling with the inflationary consequences of the Middle East energy shock. Yet gilt yields have risen materially more than those of comparable sovereigns. The UK is perceived as a high-inflation jurisdiction, with average price increases of about 3% over the past 15 to 20 years. Gilt yields have risen more sharply than those of comparable sovereigns following the Middle East energy shock. Several factors help explain this asymmetry:

Energy exposure. The UK remains significantly reliant on imported energy, making it more sensitive to global price shocks. Higher energy prices feed through into inflation and reinforce expectations of tighter monetary policy.

Inflation-linked debt. The UK has one of the highest shares of index-linked sovereign debt globally, with roughly a quarter of its debt stock tied to inflation. As RPI rises, debt servicing costs increase, amplifying fiscal sensitivity to inflation relative to peers.

Persistent domestic inflation. UK inflation has remained relatively sticky, particularly in services, contributing to expectations of "higher for longer" policy rates.

Fiscal constraints and supply dynamics. Rising debt levels and ongoing issuance needs, combined with central bank balance sheet reduction, have added upward pressure on gilt yields. It should be noted that net supply is expected to decline over the coming years.

Risk premia. Investors are demanding higher compensation to hold UK debt, reflecting a combination of global uncertainty and domestic policy risks.

VI. What would it take to stabilise the Gilt market?

Stabilisation requires addressing all three components of the current sell-off simultaneously. There is no single lever.

Political resolution. The most immediate requirement is clarity on the UK's political leadership and, critically, its fiscal framework. A new leader who credibly commits to the existing debt rules, and is believed by markets, could compress the political risk premium. If the Chancellor's proposed fiscal buffer measures are viewed as credible by markets, this could create a virtuous circle for UK public finances as gilt yields fall due to reduced fiscal risk and the prospect of easier monetary policy.

Inflation credibility. The Bank of England must demonstrate that it will act to contain inflation without triggering a recession. A tightening of rates could help anchor inflation expectations but risks exacerbating the growth slowdown and worsening the fiscal position. The interplay between energy prices, growth, and fiscal credibility is the central challenge for UK rates.

Supply management. With gilt supply falling sharply in 2026-27, this could support a gradual improvement in market conditions.

Bank of England backstop. If market dysfunction emerges, a rapid, disorderly move rather than a gradual repricing, the Bank of England retains the option to pause active gilt sales under QT, reverting to passive roll-off. A gradual, sustained rise in yields may be broadly manageable for investors, but the speed and scale of the move are critical.

Geopolitical de-escalation. Ultimately, a resolution to the Strait of Hormuz disruption would remove a major driver of the current inflation impulse. UK gilts have demonstrated a high beta to energy prices and risky assets, leading to strong rallies on positive news, such as de-escalation, and sell-offs in response to negative newsflow.

The uncomfortable conclusion is that the gilt market's stabilisation depends on factors such as geopolitical resolution, political succession, and inflation dynamics that are largely outside the government's direct control. Until clarity emerges on at least two of these three fronts, elevated yields and a wide gilt-Bund spread are likely to persist.

From an investor perspective, current yields are attractive and clearly warrant close monitoring of the situation. Depending on risk appetite, this creates opportunities to add exposure, but it is probably still too soon given that the risk of spreads widening further remains high.