Gilts: A Cautious Thaw as the BoE Navigates Between Persistence and Weakness

UK long-term gilt yields have traced a clear downward path since their September 2025 peak. The FRED long-term gilt yield series (IRLTLT01GBM156N), which tracks 10-year-plus maturities, shows a steady decline from 4.69% in September 2025 to 4.45% in January 2026 — a drop of approximately 24 basis points over four months. This easing accelerated through the fourth quarter of 2025, with yields moving from 4.57% in October to 4.50% in November and 4.48% in December, before settling at 4.45% in the latest reading.

To put this in perspective, UK long-term gilt yields remain well above their early-2024 levels of roughly 3.93% and their late-2023 trough near 3.86%, reflecting the persistent repricing of inflation expectations and term premium that characterised 2024 and much of 2025. The January 2025 spike to 4.66% — driven by global bond market turbulence and fiscal concerns — marked the cycle high before the gradual descent began.

Compared with US Treasuries, gilts have maintained a notable spread. The US 10-year Treasury yield stood at 4.08% as of February 19, 2026, having declined from around 4.29% in early February. That places the UK-US long-term spread at roughly 35–40 basis points — a premium that reflects the UK's stickier inflation profile, a more constrained fiscal position, and ongoing structural concerns about gilt supply. While US yields have been volatile on a day-to-day basis — ranging from 4.04% to 4.29% in February alone — the general direction has mirrored the UK's move lower.

The US yield curve, meanwhile, has maintained a positive slope, with the 10-year minus 2-year spread at 0.60–0.62% in late February. The US 2-year yield at 3.47% sits approximately 61 basis points below the 10-year, signalling that markets expect the Federal Reserve's easing cycle to continue — a backdrop that has indirectly supported gilt valuations by anchoring global rate expectations.

The Bank of England's February 2026 Monetary Policy Report laid bare the tensions at the heart of UK rate-setting. The MPC voted 5–4 to hold Bank Rate at 3.75%, with a substantial minority of four members preferring an immediate 25 basis point cut to 3.50%. This was the tightest split since the easing cycle began in August 2024, when the Bank first cut rates from a peak of 5.25%.

The case for patience rests primarily on inflation. UK CPI stood at 3.4% in December 2025, well above the 2% target, and services price inflation — the BoE's preferred gauge of domestic price pressures — remains elevated. Wage growth, while moderating, has yet to fall to levels the MPC considers consistent with sustainably hitting the target. The February Report introduced new analysis of 'target-consistent' wage growth and found that structural changes in wage-setting behaviour are not, on balance, adding to inflationary pressures — a reassuring finding, but one that does not yet justify complacency.

The case for cutting is building, however. The BoE's own assessment acknowledges that 'the risk from greater inflation persistence has continued to become less pronounced,' while downside risks from weaker demand and a loosening labour market are growing. Crucially, the Bank expects CPI to fall back 'to around the target from April,' driven by energy price dynamics and the fiscal measures announced in Budget 2025. The household saving rate remains above historical norms, suggesting consumers remain cautious, and labour market conditions are loosening — raising the spectre of a more pronounced rise in unemployment if policy remains too tight for too long.

The Bank's forward guidance is clear: 'On the basis of the current evidence, Bank Rate is likely to be reduced further.' But it also warned that 'judgements around further policy easing will become a closer call,' explicitly flagging the risk of cutting too quickly. The next MPC decision is due on March 19, 2026, and market pricing currently implies a strong probability of a cut, though the split vote suggests it will be contested.

For context, the Federal Reserve has followed its own easing path, cutting the Fed Funds Rate from 5.33% in mid-2024 to 3.64% in January 2026. The parallel easing cycles have kept US-UK rate differentials relatively stable, though the BoE's more cautious pace — six cuts totalling 150 basis points versus the Fed's more aggressive 169 basis points — reflects the UK's stickier domestic inflation dynamics.

The UK government's fiscal position remains a central factor in gilt market dynamics. Chancellor Rachel Reeves' Autumn Budget 2025 was broadly well-received by bond markets, with the Financial Times noting that the Budget 'calmed investor nerves' and prompted Vanguard to plan increased gilt purchases. The fiscal package boosted the government's headroom against its borrowing rules to approximately £22 billion, and the emphasis on fiscal discipline helped calm the bond vigilantes who had rattled markets earlier in the autumn.

However, the gilt market's relief proved short-lived. In mid-November 2025, a government U-turn on planned income tax rises triggered a sharp sell-off in gilts, with borrowing costs jumping as investors questioned the credibility of the fiscal framework. While bonds subsequently stabilised — aided by cabinet expressions of support for Prime Minister Starmer in early February 2026 — the episode was a reminder that political risk remains a live factor in gilt pricing.

On the supply side, the Treasury has signalled a significant structural shift in its borrowing strategy. In January 2026, HM Treasury announced plans to promote short-term Treasury bills to retail investors, part of a broader push to reduce reliance on long-term debt issuance. This follows a late-2025 announcement that the government was considering expanding the short-term debt market in what was described as a 'radical' borrowing shift. The rationale is clear: with demand for longer-term gilts fading relative to supply, shortening the maturity profile of government debt could reduce issuance costs and ease pressure on the long end of the curve.

Perhaps most notably, the Treasury has taken a key step toward digital gilt issuance in 2026, appointing HSBC and the law firm Ashurst to lead the project. First announced by Reeves in 2024, digital gilts would represent a landmark modernisation of the UK's debt infrastructure, potentially improving liquidity and broadening the investor base. While the immediate market impact is limited, the move signals a government that is actively innovating in how it manages its roughly £2.6 trillion debt stock.

The interplay between ongoing quantitative tightening (QT) — the Bank of England's programme to reduce its gilt holdings — and heavy government issuance continues to weigh on valuations. The BoE's QT programme has been a source of additional supply pressure, though recent commentary has questioned whether active QT remains appropriate given the economic backdrop.

The UK gilt market does not operate in isolation, and the global backdrop heading into late February 2026 is defined by three intersecting forces: synchronised central bank easing, trade policy upheaval, and diverging growth trajectories.

The Federal Reserve's easing cycle has been a tailwind for global bond markets. With the Fed Funds Rate at 3.64% in January 2026 — down from 5.33% in mid-2024 — US monetary policy has shifted decisively, and the positive US yield curve (10Y-2Y spread at 0.60%) confirms that markets expect further easing ahead. This has compressed global term premiums and created a more supportive environment for sovereign bonds broadly, including gilts.

However, the US Supreme Court's landmark ruling on February 20, 2026 — striking down President Trump's 'reciprocal' tariffs as unconstitutional — has injected fresh uncertainty into the global outlook. While the ruling removed a significant overhang on global trade, Trump's immediate announcement of a new global 10% tariff and the persistence of Section 232 duties on steel, aluminium, autos, and other sectors means that trade frictions remain elevated. For the UK, which struck a bilateral deal reducing auto tariffs to 10–15%, the direct impact is mixed — but the broader implications for global growth and inflation expectations ripple through the gilt market via international capital flows and risk appetite.

The Financial Times reported in late January 2026 that European and UK growth stocks were staging a comeback as government bond yields declined, suggesting a rotation dynamic where falling gilt yields are supporting risk assets and potentially reducing safe-haven demand for government bonds. This 'push-pull' between declining yields boosting asset prices and reducing the relative attractiveness of gilts is a key dynamic for investors to watch.

Wall Street investment banks had predicted in late 2025 that gilts would outshine global peers in 2026, helped by BoE rate cuts. That thesis has been partially validated by the yield decline from 4.69% to 4.45%, though the pace of outperformance has been more modest than some bulls anticipated, given the stickiness of UK inflation and the political wobbles that periodically rattle the market.

For individual investors, the gilt market in February 2026 presents a nuanced opportunity set. Long-term gilt yields near 4.45% offer an income stream that remains historically attractive — well above the sub-2% levels that prevailed through much of the 2010s — and the BoE's signalled intention to cut rates further provides a potential capital gain catalyst as bond prices rise when yields fall.

The bull case centres on the conviction that UK inflation is set to decline materially. The BoE expects CPI to fall to around 2% from April 2026, driven by base effects in energy prices and the fiscal measures in Budget 2025. If this materialises, the case for further rate cuts strengthens, and long-duration gilts stand to benefit significantly. A move in long-term yields from 4.45% toward the 4.00% level — not unreasonable if the BoE cuts two to three more times in 2026 — would deliver meaningful total returns for holders of longer-dated bonds.

The bear case, however, is not trivial. Services inflation remains sticky, wage growth is only gradually moderating, and the 5–4 MPC split reveals genuine disagreement about the appropriate pace of easing. If inflation proves more persistent than expected — perhaps due to renewed energy price pressures or global trade disruptions feeding through to UK import costs — the BoE could pause its easing cycle, disappointing rate-cut expectations and pushing gilt yields higher. The term premium embedded in UK bonds also remains a risk: with the government's heavy issuance programme and ongoing QT, the supply-demand balance for gilts could deteriorate if foreign or institutional demand weakens.

Political risk adds another layer. The Starmer leadership speculation in February, the late-2025 fiscal U-turn, and the broader uncertainty around UK economic policy mean that gilts carry a political risk premium that comparable US or German bonds do not. The appointment of Peter Mandelson as US ambassador — which triggered a brief sell-off in sterling — illustrates how political headlines can move bond markets even when fundamentals are stable.

For portfolio construction, investors should consider their duration exposure carefully. Shorter-dated gilts (2–5 years) offer less yield but greater insulation from inflation surprises and political volatility. Longer-dated gilts (10 years and beyond) offer higher yields and greater rate-cut upside, but with commensurately higher risk. The Treasury's push to promote retail access to Treasury bills provides a new avenue for conservative investors seeking government-backed income with minimal duration risk.