Bounce in gilt yields may not last (Nov 09)

Gilt yields have risen over the last month, with 10-year yields close to half a percentage point higher than a month ago. The Monetary Policy Committee’s decision at its meeting in November to extend quantitative easing by only £25bn – suggesting that this was the last extension of the scheme – certainly played a part in pushing yields higher. But the continued rise in break-even inflation rates appears to have played a more fundamental role. In the near term, a temporary pick-up in inflation over the next few months could see break-even inflation rates rise even more. But further ahead, the large amount of spare capacity in the economy is likely to keep inflation very low for an extended period – and much lower than markets currently expect. In light of this, we continue to think that gilt yields have plenty of room to fall.