The Governor of the Bank of England expects to lower the bank rate in the future, but we don’t know exactly when or by how much. Despite some global factors affecting long-term gilt rates, there is no sign of stress in the gilt markets. Currently, the market predicts a drop of 33 basis points by next July.

Opportunity in Divergence

There is a chance to take advantage of the difference between the Bank of England’s cautious tone and the market’s low expectations for rate cuts. The market thinks only 33 basis points of easing will happen by next July, which seems low considering the Governor’s hints at further reductions. This indicates a disconnect that we can use to our advantage in the coming weeks. Recent economic data supports the need for more easing than the market currently anticipates. The UK’s Consumer Price Index (CPI) for August 2025 dropped to 2.8%, indicating a clear downward trend, while GDP growth for Q2 2025 was only 0.1%. These numbers give the Monetary Policy Committee the opportunity to stimulate a slowing economy. Therefore, we should look to increase positions that will benefit from decreasing short-term UK interest rates. This may involve receiving on short-end SONIA swaps or buying front-end Short Sterling (SONIA) futures contracts. The aim is to take advantage of the market adjusting to the possibility of at least two 25 basis point cuts by mid-2026. However, the global situation pushing up long-term gilt rates presents a different challenge. The US Federal Reserve is maintaining steady rates after the August 2025 non-farm payrolls report showed a strong addition of 250,000 jobs. This external pressure will likely keep 10-year and 30-year gilt yields high, regardless of the Bank of England’s actions.

Ideal Environment for Yield Curve Steepener Trades

This situation is perfect for yield curve steepener trades. We can position ourselves for the spread between 2-year and 10-year gilt yields to widen by buying 2-year futures and selling 10-year gilt futures. This strategy profits as the front end of the curve rises on rates cut expectations while the long end remains stable due to global pressures. The uncertainty surrounding timing also suggests an increase in interest rate volatility. Given the instability in gilt markets from 2022 to 2023, we know that guidance can change rapidly. Buying derivatives like swaptions or options on SONIA futures could be an affordable way to gain exposure to unexpected rate movements in either direction. Create your live VT Markets account and start trading now.

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