SONIA: Net Short Cover In SFIZ5 After CPI

Gilts have stabilised after Friday’s sharp sell off.

• Chancellor Reeves’ reported u-turn on income tax rate hikes has not triggered an ongoing round of all-out market panic linked to worries surrounding the UK fiscal situation, with the resulting adjustment contained to one session.
• While benchmark yields are still 5-13bp off Thursday’s closing levels, they remain well below October highs.
• We previously noted that swap spreads remain some distance above year-to-date lows, which suggests that there is far less fiscal risk premium in the price vs. what seen during other stages of the year (admittedly with spillover from U.S. and German swap contributing to the recovery from lows multi-month).
• Looking ahead to next week’s budget, ING believe that the idea that “roughly half the fiscal hole is filled by upfront tax hikes feels like it is well priced now. Unless tax hikes are much less frontloaded in 2026, we doubt gilt yields need to rise materially on the back of this budget”. They also see a high bar when it comes to the budget blocking a cut from the BoE in December.
• Ultimately, they believe that “inflation should slow quickly, restoring confidence in a lower policy rate. Lower rates underpin the cost of financing positions for foreigners but may also help to restore needed confidence in fiscal management, Meanwhile shortening gilt supply and very moderate long-end QT should help to address the loss of historical support from UK pensions”.
• As a result, ING think UK 30-Year gilt yields could fall back to 4.40%.
• They suggest that the main risk to that view stems from political risks/a potential leadership challenge within the ruling Labour Party.

• EUR/USD: $1.1600-05(E915mln), $1.1675(E1.4bln), $1.1700(E1.0bln)
• USD/JPY: Y153.00($1.3bln)