The Bank of England Governor anticipates future reductions in the bank rate. However, the exact timing and magnitude of these cuts remain uncertain.
Despite the global conditions affecting long-term gilt rates, there is no perceived stress in the gilt markets. The market currently expects a reduction of 33 basis points by next July.
Opportunity In Divergence
Given the divergence between the Bank of England’s dovish tone and the market’s shallow pricing for cuts, we see an opportunity. The market is only pricing 33 basis points of easing by next July, which seems low if the Governor is explicitly signaling further reductions. This suggests a disconnect we can position for in the coming weeks.
Recent economic data supports the case for more aggressive easing than is currently priced. The latest UK CPI reading for August 2025 fell to 2.8%, showing a clear downward trend, while Q2 2025 GDP growth was a sluggish 0.1%. These figures give the Monetary Policy Committee the room it needs to stimulate a cooling economy.
Therefore, we should consider adding to positions that benefit from falling short-term UK interest rates. This could involve receiving on short-end SONIA swaps or buying front-end Short Sterling (SONIA) futures contracts. The goal is to capture the repricing as the market digests the likelihood of at least two full 25 basis point cuts by mid-2026.
However, the comments on global conditions pushing up long-term gilt rates present a different challenge. The US Federal Reserve is holding rates firm after the last non-farm payrolls report for August 2025 showed a surprisingly strong 250,000 jobs added. This external pressure is likely to keep 10-year and 30-year gilt yields elevated, regardless of BOE actions.
Ideal Environment For Yield Curve Steepener Trades
This environment is ideal for yield curve steepener trades. We can position for the spread between 2-year and 10-year gilt yields to widen by simultaneously buying 2-year futures and selling 10-year gilt futures. This strategy profits from the front-end of the curve rallying on rate cut expectations while the long-end remains anchored by global factors.
The mentioned uncertainty on timing also suggests an increase in interest rate volatility. Looking back at the instability in gilt markets during the 2022-2023 period, we know that guidance can change quickly. Buying derivatives like swaptions or options on SONIA futures could be a cost-effective way to gain exposure to larger-than-expected rate moves in either direction.
