Demystifying the bond market

Ann Pettifor explains the Bank of England is the bigger problem

Despite the uncertainty, the FT, senior right-wing Labour officials and other commentators pounced on the news of Andy Burnham’s candidacy in a parliamentary by-election. His candidacy, they declared, would “rattle the markets”. The FT reminded us of:

“The harsh reality facing all British politicians: whoever runs the government will be in thrall to a bond market that holds growing sway over debt-laden major economies”.

A Labour Party official offered this insight – ominously and anonymously:

“This would be the first party leadership contest where the bond market has a vote”.

The first party leadership in which imagined bond markets have a vote?

Is he delusional?

Bond traders and how they work.

To understand why bond markets are “rattled”, it helps to understand how they work.

Traders buy British government assets (bonds, or debt) and hold those assets for a fixed term i.e. period of time; for a fixed rate of return (interest, or yield).

Now think of the bond market as a market for, say, tomatoes. Think of the “yield” as the “price” of tomatoes in that market. Whereas in a real tomato market, the price of ALL tomatoes can change by the hour, or by the day or week, that does not happen in the bond market.

Instead, it (the “price” or yield) only changes for new bonds arriving in the market, at a higher or lower rate of interest.

And changes in the bond market are driven by the actions of central bankers – not by bond traders. Bond traders are just reacting, or second-guessing in advance the likely decisions of central bankers to raise or lower rates.

If a trader is holding a bond contract whose “price” is fixed at say, 3 or 5 per cent, repayable over 2 or 10 years, the trader is stuck with that bond at that price – unless she sells it.

When unexpectedly the “independent” governors of the Bank of England change their mind on the direction of interest rates and hint they will increase the “price” of new bonds to more than 5%, their decision poses a threat to bond traders holding existing bonds at 3-5%,

Why do Bank governors raise rates?

To tackle inflation, they argue. In other words, the Bank threatens to do something the governor of the Bank of England once declared not possible – ie, to tackle inflation by raising rates.

 On 16 May 2022, the Governor of the Bank of England told Members of Parliament in a public hearing that

“It’s a very, very difficult place to be. To forecast 10 per cent inflation and to say there isn’t a lot we can do about it is an extremely difficult place to be.”

Despite this admission of the impossibility of tackling inflation by raising rates, he and his committee are obliged to raise rates.

Knee-jerk reactions

Central bankers have been raising rates to “dampen inflation” for nearly fifty years – since Paul Volcker first used the interest rate weapon to tackle inflation back in October 1979.

Inflation erodes the value of loans/bonds lent by creditors, while it relieves debtors of the burden of debt. In other words, a creditor may get back only £90 of a £100 debt in an inflationary environment.  Deflation or disinflation increases the value of debt. In other words, the creditor gets back £110 from a loan of £100.

Bleak Thursday

On Thursday, 19 March 2026, bond traders read a Bank of England statement which hinted the Bank would raise rates in the future. New bonds would therefore have a higher “price” (yield). The language used by the governors is well understood: that rates are rising to prevent “second-round effects” – meaning wage rises. Thus, high rates are deployed to force down wages. To quote the Bank’s governors:

“A larger or more protracted shock, which risked greater second-round effects in wage and price setting, would require a more restrictive policy stance”.

A “restrictive policy stance” here means “higher rates”. As the FT explained:

“The volte-face on rates was encouraged by the BoE itself, which on Thursday warned on inflation and opened the door to future rises even as it kept borrowing costs on hold…”

The Bank’s volte-face

On reading the Bank’s statement and the FTs, bond traders naturally panicked. Their “short-dated” bonds could suddenly be made worth less – or so they reckoned. The rate of return on their existing bonds was soon going to be lower, they judged, than the rate of return on new bonds. 

Instead of holding on to bonds that would be worth less than the expected new going rate in the market, bond traders reacted rationally. They launched “a violent sell-off” of their bonds and began “front-running” the Bank.

By selling all their bonds, they shrank the immediate availability of those particular bonds, which created a shortage of bonds at a “price” of 3 or 5 per cent repayable over 2 or 5 years. (’Short-dated” bonds). That shortage meant that the price (yield) of short-rated bonds would rise, much as the price of tomatoes would rise in a market short of the fruit.

Bond traders were, and are, acting rationally to their perception of an impending threat to the value of their investments. Unfortunately, because this is The Global Casino, their actions were amplified by what the BoE calls “the growing influence of speculative investors such as hedge funds”, which have

“the potential to exacerbate swings in the gilt market ….a growing force in UK government debt. Hedge funds that had accumulated large bets on lower BoE interest rates in recent months rushed to ditch those bullish positions as the market moved against them, exacerbating the sell-off, analysts said.

Who will be the biggest losers of a rise in the Bank rate?

Bond traders would not be the only losers.

By threatening to raise rates, the Bank will set out to worsen the public finances and downgrade the value of sterling at the very time the government will need support from its most powerful institution. Thanks to the Bank of England’s expected rate rises, that intervention will cost taxpayers a lot more, will increase the government’s debt burden, and will undermine confidence in the government’s actions.

In other words, the Bank of England’s actions will affect fiscal policy – an area of the economy in which they should stay out of.

Plus, rate rises will harm an already weakened, risk-averse and low-investment private sector.

The biggest losers will be you and me – the nation’s consumers.

Millions of individuals and families have, for some years now, been coping with a cost-of-living, or “affordability” crisis.

Higher rates will worsen the cost-of-living crisis by increasing the cost of borrowing, both for households and for firms.

And the higher cost of borrowing will feed through the economy and suppress “demand” for goods and services provided by the private sector.

In other words, higher rates will suppress the nation’s purchasing power.

Demand for goods and services is already weak – largely because wages are stagnant or falling. That explains why the British economy has failed to recover after both the Global Financial Crisis and COVID crises, and to expand.

Consumers already enduring a cost-of-living crisis cannot afford to spend or invest. The TUC explains:

“As new ONS figures show consumer demand slowed to 0.2% in Q4, new analysis by the TUC suggests a key feature of the UK’s growth problem is a lack of consumer demand – our shoppers don’t have the money or confidence to spend.

“The UK is languishing near the bottom of consumer spending internationally – ranking 32 out of 36 OECD countries over the last three years”.

And if shoppers will not spend, then shop owners/landlords/the service sector will suffer. The Bank of England’s governors will not, it appears, come to their aid. Instead higher central bank rate rises will benefit creditors, and feed through into the pockets and bank accounts of millions of people. Living standards will fall.

Who will be blamed? The media – and their friends in the economics profession – will not blame the Bank of England.

They will blame the same old bogeymen and women: “bond vigilantes”- as before.

Ann Pettifor’s latest book, The Global Casino (Verso) was reviewed in last Chartist