Gap between US and UK borrowing costs at widest in 25 years

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Electoral jitters may be driving yields gaps to four-year highs in the eurozone, but the prospect of the first Federal Reserve rate hike of Donald Trump’s presidency has sent treasury yields soaring to the highest level above UK gilts in 25 years.

Diverging paths for the US and UK central banks has pushed the gap between 10 year Treasuries and gilts to 136 basis points (1.36 percentage points) – the highest since 1992 according to data from Bloomberg.

Treasury yields have climbed sharply in the wake of Mr Trump’s election in November as investors shun US debt in a world of steadily rising inflation, tighter monetary policy, and the prospect of stronger economic growth under the new White House administration.

But while the Fed prepares to fire the gun on its latest round of monetary tightening next week – pushing up US borrowing costs – the Bank of England has stressed it remains “neutral” on its record low interest rates in the wake of the Brexit vote in June.

Britain’s 10-year gilt yield stands at 1.2 per cent – falling steadily from a 2017 peak of 1.5 per cent hit in February. Despite higher inflation, yields have come off in recent weeks as latest data suggests the UK’s resilient economic growth since the Brexit vote has been cooling, lessening the pressure on the BoE to lift rates.

The BoE has also helped keep a lid on yields by renewing its quantitative easing measures with a £60bn bond-buying package announced last August.

A reduction in net UK debt issuance should also dampen gilt yields following the country’s latest annual budget. Britain’s Debt Management Office now estimates gross issuance to decline by £30bn over the next 12 months as the government’s borrowing bill shrinks in 2017/2018.

“A combination of lower supply and upbeat US data should keep the outperformance of gilts intact”, notes Peter Schaffrik at RBC Capital Markets.

But higher interest rates from the Fed, combined with historically loose monetary policy in the UK, is bad news for the pound.

Sterling has fallen 18 per cent against the greenback since the referendum but has found its feet for most of this year, slipping just over 1 per cent at $1.2183.

The pound could face further weakness once the UK begins its official EU exit procedures next month should Brexit talks get hairy. Analysts at Bank of America Merrill Lynch think investors are currently under-pricing a risk of the British government staging a walk-out during the two-year negotiations.

“Our concerns that Brexit negotiations will have a troubled start once Article 50 is triggered lead our FX strategists to forecast [sterling] falling to $1.15 in the near term”, says Mark Capleton at BAML.

“Sell the pound” is also the message from Societe Generale’s Kit Juckes.

“Sterling’s in trouble even before we watch the Government twist itself into a mess about the [Budget's] National Insurance rate increase and wander into triggering Article 50″.

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