PIMCO and other investors stick with UK gilts, see rate cuts easing market pain

By Harry Robertson and Yoruk Bahceli

LONDON (Reuters) - PIMCO and other major investors said they were staying in the market for British government bonds despite the recent turmoil, throwing finance minister Rachel Reeves a potential lifeline as she tries to quell a multi-day sell-off in UK debt.

Asset managers said the sharp rise in UK borrowing costs in recent days is likely to force Reeves to cut spending or raise taxes, weighing on UK growth and raising the likelihood of deeper-than-expected Bank of England rate cuts, which could soothe markets.

Britain's benchmark 10-year government bond yield on Thursday touched 4.925% , its highest since 2008, surging more than 30 basis points in three days. Meanwhile, the pound slid to its lowest level since November 2023 at $1.224.

Yet the sell-off eased later on Thursday and 10-year and 30-year bond yields were last flat on the day. Yields rise as prices fall and vice versa.

PIMCO, one of the world's largest asset managers overseeing $2 trillion, said it remained positive on gilts and that much of the sell-off had been driven by a sharp rise in U.S. yields, reflecting a strong domestic economy there.

U.S. 10-year bond yields have risen 50 basis points over the last two months, while UK 10-year yields are up 55 bps. However, British yields have risen around 10 bps more than their U.S. peers this week.

PIMCO economist Peder Beck-Friis told Reuters late on Wednesday that a fiscal contraction is likely. "Both weaker growth and higher interest rates put pressure on public finances," he said.

"If the current trends of rising yields and slowing growth persist, the chances of spending cuts or tax increases will increase for the government to adhere to its new fiscal rules."

UK deputy finance minister Darren Jones on Thursday stressed the Labour government's commitment to rules that target a balanced day-to-day budget by 2029-30 in an effort to calm market nerves.

Craig Inches, head of rates and cash at Royal London Asset Management, said UK debt sustainability was a concern and downward pressure on growth from tax hikes or spending cuts would dent revenues when borrowing is already high.

But he added he has been buying more UK debt because the rise in yields made them offer "great value".

Some investors argued that the BoE is likely to cut rates more than the market currently expects. Money markets currently point to fewer than two 25-basis-point cuts this year.

"A shift in the government's fiscal stance would begin to present further downside growth risks for the UK economy this year," said Ranjiv Mann, senior portfolio manager at Allianz Global Investors.

"We think the market is likely to begin pricing a more dovish BoE relative to current pricing in the months ahead." Interest rate cuts tend to help bonds by boosting the appeal of those securities with higher yields currently in the market.

However, RBC BlueBay Asset Management fund manager Neil Mehta said he saw no reason why long-dated UK government bond yields couldn't rise as high as 6%. UK 30-year yields last traded at 5.364%, around their highest since 1998.

"This boils down to deteriorating growth expectations, while at the same time it looks like inflation has bottomed and moving up again," he said.

Matthew Amis, investment director at abrdn, said he will be assessing market moves over the next 24 hours.

"Once the gilt market starts to move, it starts to move," he said. "There's no point in standing in the way of that."

(Reporting by Harry Robertson and Yoruk Bahceli; editing by Dhara Ranasinghe, Amanda Cooper and Toby Chopra)