The U.K. market has been sending mixed signals recently to say the least. Inflation’s stayed sticky, gilt yields have crept up, yet U.K. equities are floating around all-time highs. It’s easy to ignore this information as just numbers on a screen, but for British households and businesses they have a real effect. From higher mortgage payments and groceries to higher financing costs and tougher conditions for investment.
So what’s really driving the mood in markets right now? In today’s blog, we’ll break it down by looking at three simple charts: inflation, gilt yields, and equities. Together, they tell a story of why prices keep ticking up, why borrowing costs have jumped, and why investors are cautious but not panicked.
Chart 1: Inflation – Why Prices are Staying Sticky
The first and most important statistic we need to watch out for is inflation. In July, the U.K. CPI came in at 3.8%, increasing from 3.6% in June and coming in 0.1% higher than economists expected. This puts U.K. inflation at almost double the Bank of England’s target rate of 2%. At first this might not sound dramatic, but the details show why there has been concern.
Food prices are rising at nearly 5%, with services inflation sitting at 5% as well. Extreme weather has hurt harvests, while higher input costs have pushed up farming expenses. Combine this with global transport bottlenecks and rising labour costs in agriculture and retail, and it’s clear to see why weekly shops remain so expensive. Services matter because they’re closely tied to wages. While pay growth has cooled from the extreme 7%-8% peaks of 2023-2024, it’s still running close to 4%-5%. That’s well above the rate consistent with the 2% inflation target. This creates a problem. Businesses experience higher costs due to higher wages, so they pass this cost on to consumers by increasing prices. This keeps inflation for services like restaurants, transport and care high.
Before, energy bills were the big driver of inflation, but this has eased off from its peak. However, the aftereffects are still being felt as they ripple through supply chains, as businesses continue to experience higher transport, heating and production costs.
This inflation situation plays havoc with the Bank of England’s monetary policy. They began cutting rates in late 2024, but with inflation still near 4%, justifying quick cuts will be difficult.
The base rate of 4% is lower than last year’s peak of 5.25%; however, it seems we are still a long way away from the near 1% pre-Covid rates. Bad news for businesses and households, as mortgages and other loans are likely going to remain expensive for longer.
Chart 2: U.K. Gilt Yields – Why Borrowing Costs Are Rising
The second chart we need to look at is the yield on U.K. government bonds, or gilts. The 10-year yield is hovering around 4.6%-4.7% and reached as high as 4.8% last week. This is a steep increase from the 3.9% yields we saw a year ago and puts the U.K. 10-year among the highest yielding in the G7. When bond yields climb like this, it doesn’t just impact investors. Every move higher in the bond market trickles down through the economy, as gilts set the benchmark for mortgages, corporate loans, and the government’s own debt repayments.
So what’s caused the surge in gilt yields?
Sticky Inflation – As we’ve seen, inflation has remained high at around 4%. Bond investors demand greater returns to protect against losing purchasing power over time, since the fixed payments from gilts are worth less in real terms as prices are rising.
Bank of England Policy – Even though the BoE has begun cutting rates, inflationary pressures are causing more cautious and delayed cuts. Therefore, markets expect borrowing costs to be higher for longer, keeping gilt yields elevated.
Government Borrowing – Since the COVID-19 pandemic, nations all over the world have accumulated more debt. The U.K. Treasury is still issuing high quantities of gilts to refinance maturing debt and finance spending. When issuing new bonds, the Treasury has to offer higher yields to persuade investors to buy new bonds rather than existing ones.
Global Backdrop – U.S. Treasury yields are also elevated, sitting around 4%. Because Treasuries are viewed as the ultimate safe-haven bond, global investors often compare all other debt against them. To hold U.K. gilts instead, they usually want a small premium, a risk cushion over U.S. bonds. While this premium does nudge U.K. yields higher, it’s far less important than other domestic drivers.
It’s clear that the U.K.’s inflation problems are spilling over into the bond market, with government debt levels combining to amplify the upward pressure on gilt yields. The result is borrowing costs across the economy are likely to stay higher for longer. For households, mortgage rates will remain painful. For businesses, it makes investment more expensive. And for the government, it raises the cost of servicing debt, diverting money away from public spending and tax cuts. In short, rising gilt yields are tightening the belt on the government’s already strained budget.
Chart 3: Equities — Why Stocks Are Holding Up
So inflation and bond yields are painting a gloomy picture for the U.K., however, you wouldn’t think this if you looked at the stock market. The FTSE 100 is currently trading around 9,200, just shy of the record highs it set in August. At first glance, this seems odd, however there are good reasons as to why equities are holding up.
Global Exposure – Many of the FTSE’s largest companies earn a majority of their revenue overseas (think Shell and Unilever). That protects them from the domestic pressures and supports earnings even when the U.K. economy is struggling.
Sector Mix – The FTSE 100 is made up of firms from a wide range of industries. The index leans heavily on sectors like defence and banking, both of which have had standout performances year to date. Banks have benefited from higher interest rates, which widen their net interest margin. Defence companies like BAE Systems and Babcock have seen share price increases as they capitalise on European pledges to increase defence spending.
Dividend Appeal – The FTSE 100 is packed with known dividend payers (like BP or National Grid). In times of uncertainty, investors value the reliable income dividend stocks provide.
Market Sentiment – Market sentiment seems to depict that investors believe most of the interest rate pain is already behind us. With the BoE cutting rates (albeit slowly), markets see this as a benefit for stocks in the long term.
In short, the FTSE 100’s standout performance doesn’t reflect a booming domestic economy but rather the resilience of globally diversified companies and steady dividend payouts. The FTSE story is one of cautious optimism: the index has held firm, but investors remain mindful of the disruptions that high borrowing costs and inflation could still cause.
The Takeaway
And that covers the three charts. What might once have seemed like just numbers comes together to tell the mixed story facing the U.K. economy. Inflation remains sticky, and gilt yields are towering, and that keeps both the cost of living and the cost of doing business high across the board. Yet stocks are dancing around record highs, supported by global exposure, strengths in certain sectors, and the reliability of classic British dividends.
The takeaway message is clear: pressure points in inflation and the bond market are far from resolved, but markets aren’t panicking – at least not yet. So what do you think? Can this resilience hold, or is it only a matter of time before markets crack?
