Is the sell-off in UK government bonds overdone?

While the pound continues to be the main casualty of the vote to leave the EU, UK government bonds have come under pressure recently. Indeed, the yield on 10-year government bonds has risenby around 30bp over the past month, and by about 60bp over the past two months. Granted, rising government bond yields has been an international phenomenon. But they have risen further in the UK than in the US or Germany for example, and appear to reflect concerns about the impact on the economy and inflation of a “hard” Brexit. However, the recent sell off has probably largely run its course. In particular, worries about inflation may be somewhat overdone. While CPI inflation is set to overshoot the MPC’s 2% target early next year, we think that it will peak at about 3% by 2018 – high by recent, but not historical standards. And we expect this overshoot to be transitory, rather than long-lasting. Accordingly, our end-2016 and 2017 forecast for 10-year gilt yields remains 1%.