Sterling and gilt yields fall as recession fears mount

Sterling and gilt yields tumbled yesterday as mounting fears of recession saw investors scale back bets on where interest rates will peak.

As central bankers headed to Jackson Hole in Wyoming in the US for their annual chinwag, a set of bleak reports showed private sector activity across Britain and the eurozone in sharp decline as inflation and rising borrowing costs take their toll.

The updates sparked an immediate reappraisal of the outlook for interest rates, with investors betting they may not reach 6pc in UK as feared, having been raised from 0.1pc to 5.25pc since December 2021.

The pound fell more than a cent against the dollar to as low as $1.2616 and was down half a cent against the euro to €1.1676.

Government borrowing costs also fell on the bond markets with the yield on two-year gilts falling back below 5pc, having hit 5.5pc last month. The ten-year gilt yield, which reached a 15-year high of 4.75pc last week, dropped below 4.5pc. James Smith, an economist at ING, said the moves were ‘a big repricing of UK rate expectations’ as he predicted just one further hike by the Bank of England to 5.5pc next month.

S&P Global said its barometer of activity among UK private sector firms, where 50 is the cut-off between growth and decline, fell into contraction territory. The Purchasing Managers’ Index (PMI) dropped from 50.8 in July to 47.9 in August – the lowest since January 2021 – with manufacturers and firms in the services sector suffering.

‘High interest rates continue to cast a shadow over the UK economy,’ said John Glen, chief economist at the Chartered Institute of Procurement and Supply, which compiled the report with S&P Global.

Analysts at US investment banking giant Citi predicted that both the UK and the US will fall into recession next year. And Chris Williamson, business economist at S&P Global, said the UK was on course to shrink by 0.2pc in the third quarter of the year.

‘A renewed contraction of the economy already looks inevitable,’ he said.

‘Companies are reporting reduced orders for goods and services as demand is increasingly hit by the cost of living crisis, higher interest rates, export losses and concerns about the economic outlook.’

But he said inflation was on course to fall to 4pc ‘in the months ahead’, having dipped from a peak of 11.1pc to 6.8pc.

According to financial markets, an interest rate hike from 5.25pc to 5.5pc is all but guaranteed next month while there is then a near-75pc chance the rate will rise to 5.75pc in October.

But the chances of rates hitting 6pc at any point have fallen below 50-50.