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In a promising turn for the UK economy, borrowing costs are predicted to decline in the coming year. Wall Street analysts suggest that anticipated rate cuts from the Bank of England will alleviate some of the looming concerns about the sustainability of the nation’s public finances.

Currently, the UK’s 10-year bond yield, which surged to a 16-year peak of 4.95 percent at the onset of 2025 amid fears of near-record debt levels and a widespread global bond sell-off, is projected to decrease to 4.32 percent by the close of 2026. This forecast emerges from an analysis provided by nine prominent investment banks.

Though this reduction from the present rate of 4.49 percent appears slight, it signals that UK gilts are poised to outshine US Treasuries. Investors, transitioning from a year marked by intense worry over UK government borrowing, are now focusing on the potential for decreasing interest rates and a dip in gilt issuance. In contrast, the same Wall Street projections indicate that US 10-year borrowing costs are likely to remain relatively stable at 4.18 percent.

“We anticipate that gilts will offer the best returns among major bond markets next year,” said Luca Paolini, chief strategist at Pictet Asset Management. He attributes this optimism to a combination of the Bank of England’s rate cuts, subdued economic growth, and public finances that are comparatively stronger than those of other countries.

Bolstering the confidence of gilt investors, UK inflation figures released on Wednesday showed a sharper-than-expected decline to 3.2 percent in November. This development has further fueled expectations for rate cuts, consequently exerting downward pressure on yields.

Global bond yields have risen since the Covid-19 pandemic and the end of central banks’ vast asset-purchasing programmes. But sticky inflation and worries over UK government debt issuance — at £315bn in the current fiscal year, its highest on record excluding the pandemic — have contributed to the country having the highest borrowing costs in the G7. 

This has been compounded by a waning appetite for UK government debt from pension funds — traditionally the bedrock of demand for long-term bonds — pushing 30-year yields to their highest level this century earlier in the year.

In a bid to restore market confidence and reduce what has been dubbed a “political risk premium” on UK borrowing costs, chancellor Rachel Reeves moved at the November Budget to increase the government’s “headroom” against its borrowing rules from £9.9bn to £21.7bn.

Gilts rallied in the run-up to the Budget on the expectation of such an investor-friendly shift and gained in price on the day, helped by the government announcing that it would sell less long-term debt in particular.

Among the Wall Street banks, Morgan Stanley is one of the most bullish on gilts next year, citing BoE rate cuts and improved supply-demand dynamics — with gilt issuance expected to have peaked in the current fiscal year — as reasons for its 3.9 per cent end-2026 target for 10-year yields.

JPMorgan is more bearish, saying that the risk of a leadership challenge in the Labour party after regional elections in May next year could drive up long-term borrowing costs as investors demand a premium for uncertainty. JPMorgan expects a 10-year yield of 4.75 per cent by the end of 2026.

Many investors have warned that the backloaded nature of tax rises and spending cuts planned over the next five years means they may be tough for Reeves to deliver with an election looming, and could be threatened if there is a change of Labour leadership.

Investors are at present pricing in two quarter-point BoE cuts by the end of 2026, with the first expected to come on Thursday. If stubbornly high inflation frustrates those expectations, gilt yields could face renewed upward pressure.

“While the fiscal concern has somewhat faded [following the Budget], the underlying growth and inflation trajectories will begin to matter once again,” said Rushabh Amin, a portfolio manager at Allspring Global Investments.

Data visualisation by Jonathan Vincent