Demand for gilts weakens despite soft economic news

Gilt yields have risen further over the last month despite the news that the UK has experienced deflation and the deterioration of some recent economic growth indicators. Their rise may partly reflect the influence of overseas developments – government bond yields rose in the US in response to May’s robust payrolls figures and in the euro-zone as ECB President Mario Draghi asserted that bond markets should get used to a period of higher volatility. Indeed, the recent volatility in global bond markets has prompted demand at gilt auctions to weaken to levels not seen since the financial crisis, as market makers have become concerned that they may have to sell on gilts in the secondary market at a loss. Despite this, however, we continue to think that the weak outlook for inflation and slow interest rate rises in the UK will ensure that gilt yields rise only gradually over the coming years.