UK gilt yields are forecast to decline in 2025 despite recent surge

UK government bond yields have risen amid investor concern about the government’s fiscal outlook and sticky inflation. Even so, Goldman Sachs Research projects the country’s borrowing costs will decline by the end of the year as the Bank of England cuts its policy rate.

“We still think the UK data will justify more cuts than the market is pricing,” says George Cole, head of European rates strategy in Goldman Sachs Research. Our strategists project 100 basis points of cuts in 2025, compared with the 41 basis points of cuts that’s priced into the bond market. The team forecasts 10-year gilt yields will fall to about 4% by the end of 2025 from 4.9% (as of January 13), the highest since 2008.

British bond yields, along with those of many governments, have been climbing since September. Cole says one simple reason for the broad increase in borrowings costs is that there’s a lot of government borrowing. The US ran a $1.8 trillion budget deficit last year, which was about 6% of GDP. The budget deficit in France was around 6%, and in the UK it was about 4.5%.

“There are a lot of bonds to buy everywhere,” Cole says.

Will central banks cut interest rates in 2025?

While there are idiosyncratic reasons why gilt yields have increased in the past week, the US has been an important engine behind the rise in global interest rates. The Federal Reserve cut rates by 50 basis points in September, more than some investors had anticipated.

But since then, the country’s economic data has been running hot — the US added 256,000 jobs in December, which was substantially more than economists had forecast. Goldman Sachs Research pushed back its forecast for Fed rate cuts from three cuts this year to two, with one in 2026, after the December payroll report. Investors have also questioned whether Trump administration policies such as tariffs will be inflationary.

“We may be starting to learn that cutting cycles are not going to be quite as deep as we thought, because of the near-term stickiness in inflation,” Cole says. “We don't think that that’s something you should overstate. There are still going to be interest rate cuts to come. But at the more global level, we’re experiencing a slight difficulty in digestion because those expectations for rate cuts are being pared back.”

Why gilt yields have risen

UK government bond yields, with some exceptions, roughly tracked those of the US until last week. That’s when the pound depreciated against a trade-weighted basket of currencies and the stock market showed signs of softening. Those fluctuations show that investors are demanding more compensation, or a higher risk premium, to buy UK assets.

“All UK assets need to get cheaper if that risk premium is going up,” Cole says. The increase in risk premium can reflect concern that enough isn’t being done to contain inflation, as well as worries about the outlook for deficits. In the UK, rising bond yields are pushing up government spending on interest expense, which could put the government’s budget plans at risk. A weaker currency could also drive up inflation.

In addition, Cole points out that investors are mindful that there have been other examples of the gilt yields rising alongside a decline in sterling. That’s what happened in 2016 after Britons voted to leave the EU, sparking a bout of higher uncertainty in financial markets. There was a similar episode in 2022 after the government, among other things, unveiled a budget plan with unfunded tax cuts (the event was amplified by vulnerabilities in the pension sector). Those episodes had an impact on policy making and interest rates.

So far, the British pound’s depreciation on a trade-weighted basis is small compared to previous periods of gilt market stress that sparked policy changes for interest rates, according to Goldman Sachs Research. At the same time, the government has taken steps to make UK pensions less sensitive to fluctuations in gilt yields, and expectations for economic growth, inflation, and the deficit are more positive than in 2022. Those factors make it less likely that there will be a sharp move higher in interest rates that causes financial stability concerns, Cole says.

The outlook for gilt yields in 2025

Goldman Sachs Research forecasts a decline in 10-year yields of almost a percentage point, and our analysts expect inflation to cool enough for the Bank of England to cut rates next month.

“We're fully aware that there is now slightly more fragility in that path toward the 4% mark,” Cole says. He points out that it all comes down to the data, and whether it allows the BoE to make a series of cuts below market pricing that will help the market absorb elevated bond supply.

“What could go wrong, of course, is that inflation proves to be more persistent, or there is excessive currency weakness,” Cole says. “That’s important to note in the context of the strong recent US jobs report, and another bout of weakness in the pound. If that were to start to lead to more inflationary pressure, it could make it more difficult to get those interest rate cuts. But as it stands, we still think that the UK data will justify more cuts than the market is pricing.”

 

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