The London market saw a decline on Wednesday, attributed to investors reassessing their monetary policy expectations after a significant sell-off in the bond market. Two-year gilt yields, which indicate short-term interest rate expectations, have jumped by over 4.5 per cent, leading to increased borrowing costs.
City analysts suggest that the UK's vulnerability to inflation shocks is contributing to higher gilt yields. The Bank of England has maintained interest rates at 3.75 per cent, but a cautious tone from previous Monetary Policy Committee (MPC) meetings has led analysts to believe borrowing costs could rise due to a prolonged Iran war.
The MPC warned in August that interest rates would likely be raised if a conflict re-emerges between Iran and the US. In a worst-case scenario, inflation could potentially exceed four per cent, double the Bank's two per cent target rate. Economists generally forecast UK inflation to climb above three per cent in the coming months before returning to two per cent.
Brent crude remained around $95 per barrel on Thursday, having risen for three consecutive sessions, as renewed hostilities in the Middle East and limited efforts to reopen the Strait of Hormuz continued to concern investors. RBC Capital Markets analysts expressed doubt that current interest rate pricing would be realised, though they acknowledged risks of "further weakness."