Headline inflation reached 3.5% in September from 3.1%, with motor fuels up 29.8% from a year earlier. Public borrowing came in at 24.5 billion pounds against a consensus of 23.9 billion and an official forecast of 22.6 billion, yet the 10-year gilt yield eased about 3 basis points to near 5.39%.
The United Kingdom received two pieces of bad news on Wednesday, one about prices and one about the public finances. Government bonds, which normally dislike both, rallied.
The annual rate of CPI inflation reached 3.5% for September, the Office for National Statistics reported, compared with 3.1% a month earlier. The core rate was 2.8%, from 2.6%, and the services rate was 3.7%, from 3.4%; the latter is the gauge the Bank of England uses to read domestic price pressure. Motor fuels were 29.8% higher than a year earlier, which points to the energy shock as a major source of the overshoot.
The fiscal side
Public sector net borrowing was 24.5 billion pounds in September, against a consensus of 23.9 billion and the Office for Budget Responsibility's forecast of 22.6 billion, an overshoot of 1.9 billion against the official path. Borrowing for April through September totaled 97.8 billion pounds, 6.0 billion above that path.
The overshoot comes a week before the government's budget on Oct. 28 and two weeks before the Bank of England's decision on Nov. 5. That sequence matters, because a government facing higher borrowing than forecast has less room to cut taxes or raise spending without issuing more bonds, and a central bank facing higher inflation has less room to wait.
What gilts did
The 10-year gilt yield eased about 3 basis points to near 5.39%, and the 30-year yield fell about 6 basis points to near 5.80%. Those are small moves, and they came on a day when global long-term yields were also easing: the U.S. 10-year Treasury yield was 5.112% in the afternoon, down 0.6 basis point. The evidence does not separate the gilt rally from that wider move.
Two ways to read the rally
One reading is that the market has already priced the bad news. A fall in yields on a day of poor data suggests investors had already allowed for an energy-led inflation beat and tighter policy. On that view, the larger risk is that policymakers overreact and slow growth.
The other reading is that the rally is borrowed from elsewhere. Gilts traded with global bonds, not with domestic news, and the combination of rising prices and rising borrowing has not yet been tested by a budget. On that view, the Oct. 28 statement is where the market will decide whether the figures matter.
The pairing is the clearest live test of whether UK bonds trade on monetary risk or fiscal risk. Wednesday's data pushed both in the wrong direction, and yields went the other way.
What to watch
The budget on Oct. 28, especially borrowing forecasts and planned gilt issuance; the Bank of England's decision on Nov. 5; the October inflation report in November; and the 30-year gilt yield relative to the 10-year. A rise in the 30-year yield after the budget, with the 10-year steady, would suggest that fiscal worries are being priced at the long end.