Tension in the UK and EU credit markets is reaching crisis levels Tension in the UK and EU credit markets is reaching crisis levels Tension in the UK and EU credit markets is reaching crisis levels

Tension in the UK and EU credit markets is reaching crisis levels

Christopher Dembik

Head of Macro Analysis

Summary:  The United Kingdom is becoming one major credit risk, not only for GBP assets but also for the rest of the world. Tension is increasing in global credit markets, especially in the Eurozone. Several indicators are not in the risk-zone, but it is time to stay careful. All our team are constantly monitoring the situation to provide you with the latest updates.

What is happening ?

The IMF and several rating agencies expressed concerns about UK Prime minister Liz Truss’s fiscal package :

"Given elevated inflation pressures in many countries, including the UK, we do not recommend large untargeted fiscal packages at this juncture, as it is important fiscal policy does not work at cross purposes to monetary policy" - IMF

In addition, the IMF indicated that they are "closely monitoring economic developments in Britain and [ they are ] engaged with the UK authorities". This is a very strong and unusual statement from the IMF.

Several rating agencies have also warned that the UK’s new fiscal policy regime is "credit negative" - Moody’s.

This has increased massive selling in GBP and pushed UK yield into risky territory. In the space of a few days, the UK 5-year CDS jumped to 38 basis points – this is close to the levels reached at the start of the Covid-19 outbreak – see Chart 1. This is a clear sign of market tension.

At mid-day, the Bank of England had no other choice but to step in in an effort to restore market confidence. The Bank indicated they will carry out temporary purchases of long-dated UK government bonds from today in order to "restore market functioning and reduce any risks from contagion to credit conditions for UK households and businesses". It is too early to say whether this will be successful or not.

What is the problem ?
On 23 September, the UK government unveiled a new fiscal package which will increase the level of public debt and might complicate the Bank’s task to lower inflation. This resulted in a drop of confidence in the country. This is a problem for any country facing such a situation. But this is worse for the UK. The country is more reliant than ever on inflows of foreign money to finance its excess consumption. The current account deficit was at a record high of 8.3 % of GDP in the first quarter this year. Even in the best case scenario, if it falls to 4 %, this will be complicated to finance. As foreign investors head for the exit worried about the government’s ballooning pile of debt, there is a material risk that the UK might not be able to attract enough foreign capital to fund its debt at current levels of interest. In the worst case scenario, the UK might need to be forced to sell assets to foreigners. But we are not in this situation yet.

What are the consequences ?
The UK is becoming a major credit risk not only for GBP assets but also for the rest of the world, primarily the eurozone. We see some kind of contagion effect in the eurozone credit market.

The spread between the 10-year Italian government bond and the 10-year German government bond which serves as a benchmark is above 250 basis points again – see chart 2. It is now back to pre-Covid levels when ECB President Christine Lagarde put her foot in her mouth by saying that "the European Central Bank is not here to close spreads". The widening in spreads not only reflects concerns about Giorgia Meloni’s victory in Italy but contagion from the UK credit risk too.

We also closely monitor broader measures of financial stress, such as the ECB Systemic Risk Indicator – see chart 3. It is above 0.40 – which is usually considered as the risk-zone. If it continues increasing, it could reach in a matter of weeks levels of 2011 – at the peak of the European sovereign debt crisis. Here again several factors play a role (the European energy crisis, the risk of a eurozone recession etc.). But contagion from the UK is noticeable as well.

We are now in a situation where the markets could easily break. We cannot exclude that other central banks will step in, following the examples of the Bank of England, if financial conditions continue to deteriorate. This is the right moment to be careful if you are exposed to the market.


The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-hk/about-us/awards.

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.