The Iran war and a mounting energy crisis battered UK government bonds in March, with short-dated Gilts registering their worst month in nearly three years.
But UK policymakers can still draw some comfort from the investor response to an inflationary shock that lies largely out of their control, traders say, with Gilt markets proving more resilient than during previous bouts of volatility – despite some gut-churning moves along the way.
Matthew Amis, investment director at Aberdeen, highlighted the “vulnerability" of the Gilt curve during past crises such as US president Donald Trump’s sweeping tariff announcements last April.
“Gilts seem to have a mini-episode every few months or so. But obviously, this is a lot different – it’s [driven by] geopolitics,” said Amis.
“The Gilt market ... in terms of how it’s reacted, it's probably traded how we [would] expect, which is probably a good thing for the DMO,” he said, referring to the UK Debt Management Office, which issues Gilts on behalf of the UK Treasury. “The fact that the Gilt curve flattened – which would’ve been what you expect – was somewhat encouraging.”
Short-dated government bond yields surged following the outbreak of the Iran war on February 28 as traders baked in a higher probability of central banks raising interest rates to counteract inflation. UK Gilts led the way higher.
Two-year UK yields rose as much as 120bp in March, before rallying in recent days to end the month about 90bp higher, according to LSEG data. That compares with a roughly 60bp jump in two-year German yields and a 40bp increase for Treasuries. Longer-dated bond yields also climbed, but not as fast as short-dated rates, causing yield curves to flatten.
Bearing the brunt
Traders identified several reasons why Gilts have borne the brunt of the selloff. The UK is more reliant on energy imports than many of its peers, making it particularly vulnerable to a global surge in oil and gas prices. Italy, another big energy importer, has also seen its bonds hit hard.
Market dynamics also seem to have played a role. Gilts are less liquid than other markets such as German Bunds or US Treasuries, traders say, which means large flows can have an outsized impact on prices – particularly during periods of stress.
The growing prominence of hedge funds in UK bond markets appears to have exacerbated these market swings. Hedge funds typically have a lower tolerance for losses than longer-term investors, making them more prone to sell when markets sour.
Hedge funds accounted for 60% of trading volumes in UK government bonds in early 2025, according to Tradeweb numbers from March that year, up from 46% in 2022. By comparison, hedge funds represented 55% of trading volumes in European government bonds and just 30% in Treasuries in early 2025.
“Moves in sterling markets are often greater than in euro markets because of a lower level of liquidity and a higher percentage of speculative accounts holding risk. But, equally, the UK economy is perceived as one of the most sensitive to energy shocks and inflation,” said Tom Prickett, head of G10 rates trading for EMEA at Citigroup. “The moves so far haven’t indicated a specific stress in the Gilt market – it’s more a repricing of front-end rates.”
Getting hawkish
The height of the Gilt market turmoil came in the wake of an unexpectedly hawkish Bank of England MPC meeting on March 19. The UK saw the most dramatic repricing of the likelihood of rate hikes among nine major central banks following their March monetary policy committee meetings, according to Goldman Sachs.
Two-year UK yields leapt nearly 50bp in the space of two days – their steepest rise since the September 2022 Gilt market crisis – after the BoE said it stood ready to raise interest rates. That compared with a 22bp two-day climb in German yields after the European Central Bank also signalled it could hike rates, and a 15bp increase in Treasuries after the Federal Reserve’s FOMC meeting.
Traders blame the severity of the Gilt moves on investor positioning heading into the BoE meeting, with many having started the year betting that the UK was poised to lower interest rates. When yields peaked in the aftermath of the meeting, markets had shifted to implying the BoE would hike rates four times this year.
“The Bank of England might have to hike, but not to that extent,” said Amis, who bought Gilts after yields rose. “[There were] a lot of painful stop outs across the board – from real money and fast money [investors].”
Andrew Sheets, global head of fixed income research at Morgan Stanley, said there had been uncertainty across many sovereign markets over what the policy response might be to the energy crisis and how much governments could expand fiscal policy to offset a potential hit to economic growth. However, Sheets said it is also noteworthy that UK has announced less fiscal response than other countries.
"Markets are pricing in higher inflation over the horizon, but they’re not pricing in a higher risk premium over that inflation," said Sheets, pointing to UK real rates hardly moving in recent weeks. "That distinction does matter because it suggests people aren't seriously worried about UK fiscal sustainability.”