UK rates: tactically bullish

Gilts have sold off sharply, taking 10y yields above the forecasts for the end of Q2 and Q3. Although strong UK wage developments have played a small part in the move (prompting more hawkish noises from the MPC), this has largely been externally driven. 

This is regarded as presenting a tactical buying opportunity. The third quarter has historically been a bullish one for UK rates and this year any seasonal tendency will be reinforced in a dramatic way as a heavy programme of BoE gilt reinvestments kicks off. 

Three gilt maturities (in September, December and January) will require the Bank to plough £32bn back into the gilt market in order to maintain the stock of QE at £375bn. It has committed to maintaining these reinvestments at least until after the first increase in rates. By far the biggest of the three will be the £17bn following a September 7 redemption. 

On the supply/demand side, there is also a risk that the Budget next month delivers a reduced CGNCR forecast for this fiscal year - either because of improved revenues or as a result of accelerated asset sales, This has the potential to curb the gilt financing need slightly. This new bullish bias is aligned with the directional for Bunds, which also believe have sold off too far.