While yields on gilts have continued to track those on US Treasuries closely, some decoupling is still possible. For one, both central banks have tied their monetary policy to the unemployment rate, and we believe that joblessness will fall faster in the US than in the UK. Accordingly, we think that the Fed could begin to raise interest rates in 2015, about two years before the UK MPC. What’s more, although the MPC’s guidance has not yet reduced market interest rates from the levels it has labelled “unwarranted”, it has other tools at its disposal, including more gilt purchases and a cut in the interest rate paid on banks’ reserves. As a result, we think that gilt yields are unlikely to keep rising and may yet fall back in the near-term, even as the economic recovery gathers steam.
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