Key Highlights

  • The UK 10-year gilt yield slipped below 5.4% on Thursday as safe-haven demand rose.
  • UK inflation rose to 3.5% in September from 3.1%, above forecasts, led by fuel prices.
  • September borrowing was £24.5 billion, £1.9 billion above the OBR forecast, and net debt passed £3 trillion.
  • Markets price a Bank of England hike on Nov. 5 at close to 100% and at least three increases by April 2027.

The yield on the U.K. 10-year gilt slipped below 5.4% on Thursday as concern over social unrest and rising debt in Europe pushed investors toward UK government bonds, even as British inflation overshot expectations and public borrowing swelled.

The yield closed near 5.38% on Wednesday, down about five basis points, and reached 5.36% intraday. A global bond selloff had driven the benchmark to a 19-year high earlier in September.

Inflation Surprises Higher

UK consumer price inflation rose to 3.5% in September from 3.1% in August, the highest since October 2025, the Office for National Statistics said. Economists had expected a smaller increase. Motor fuel was the main driver: fuel inflation rose to 29.8% from 23.0%, and heating oil inflation jumped to 105% from 65%, together adding about 0.2 percentage points to the headline rate, according to Capital Economics commentary. Core and services inflation also surprised to the upside.

The oil shock stems from the Middle East war. Brent crude rose toward $112 a barrel on Thursday after attacks on Saudi facilities and a U.S. order for non-emergency staff to leave Saudi Arabia.

Bank of England Under Pressure

The Bank of England held its rate at 3.75% in September, with six members voting to hold and three voting for a rise to 4%. Market expectations of a November increase are now close to 100%, with better than even odds of a second hike before year-end, according to commentary from Hargreaves Lansdown. Traders now expect at least three quarter-point increases by April 2027.

Forecasters differ on how far it goes. Capital Economics expects a quarter-point rise in November and a peak Bank Rate of 4.25%, below the 4.75% to 5.00% markets anticipate, if energy prices fall next year. ING expects another hike in February and cuts by next November, while Deutsche Bank expects two hikes in the coming months. The next decision is on Nov. 5.

Fiscal Pressure Ahead of the Budget

Public sector net borrowing was £24.5 billion in September, £1.9 billion above the Office for Budget Responsibility’s forecast, the second-highest September figure on record. Borrowing for April to September reached £97.8 billion, £6 billion above forecast. Central government debt interest was £10.9 billion, up 16.6% from a year earlier. Public sector net debt passed £3 trillion for the first time.

CMC Markets’ Laurence Booth said the Chancellor is likely to gain about £4 billion from additional VAT receipts on higher prices, leaving some room in the Budget for help. Borrowing in the first half of the fiscal year was £4.4 billion below the same period last year, so the picture is not uniformly worse.

Chancellor John Healey delivers his first Budget on Oct. 28. Capital Economics expects a cautious statement, and some major investors expect the Budget to prioritize fiscal discipline, which could help sustain demand for gilts. Higher gilt yields have also shrunk the Treasury’s fiscal headroom.

Why Gilts Rallied Anyway

Part of the dip reflects a flight to safety after Thursday’s global tech selloff, and part reflects reduced expectations for a December rate increase after the inflation data. Sterling was little changed at about $1.33.

What to Watch

The Budget on Oct. 28 is the key risk for gilts. It will show whether Healey leans on tax rises and spending restraint or leaves room for borrowing. The Bank of England’s Nov. 5 decision and the vote split will follow. A further jump in oil would push inflation expectations and yields higher.

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