07:54 AM EDT, 09/03/2025 (MT Newswires) -- The broader move higher in longer-term yields on Tuesday highlighted the fact that there are numerous countries where fiscal risks and debt sustainability concerns are increasing, said MUFG.

The United States, Japan and France all have metrics that, in many examples, are worse than the United Kingdom, but it was sterling (GBP) that was the clear underperformer within the G10 space, wrote the bank in a note to clients. GBP/USD had its biggest one-day percentage drop (1.12%) since the period of currency volatility in April when United States President Donald Trump first announced his global tariff plans on the so-called Liberation Day on April 2.

Tuesday was somewhat different, with steepening yield curves and debt sustainability the driver, which again prompted investors to consider the U.K. as the biggest risk, stated MUFG. Not only was sterling the underperformer, but the 30-year Gilt yield increased by marginally more than in Germany or the U.S.

The 30-year Japanese government bond yield jumped 7bps on Wednesday. If debt measures like overall debt-to-GDP, or net debt, or the outlook for fiscal deficit or primary deficits aren't as bad in the U.K. as elsewhere, why does the U.K. look more vulnerable to these episodes of increased debt sustainability concerns, asked the bank.

The compelling evidence of much stickier inflation in the U.K. than in the eurozone or the U.S. is certainly part of that, pointed out MUFG. The European Central Bank has cut by 200bps from a lower peak compared with the 125bps from the Bank of England.

While the Federal Reserve has cut by a little less -- 100bps -- the OIS curve shows much more easing expected in the U.S. than in the U.K. So monetary policy and the stronger inflation and wage growth are certainly part of that, added the bank.

Secondly, no other key central bank has been outright selling bonds as part of quantitative tightening (QT). That may change this month when investors get an update of QT plans going forward, but this factor hasn't helped.

Finally, the government's approach to fiscal policy hasn't instilled confidence amongst investors. Two attempts to restore fiscal credibility -- October 2024 and March 2025) failed and a third attempt is coming.

In hindsight the Labour election manifesto commitment not to raise VAT (sales tax), income tax and national insurance was a mistake, noted MUFG. Rumors of the latest tax rising plans -- wealth tax, inheritance tax, property tax increases -- haven't helped restore confidence.

Still, these factors didn't stop a record-breaking 14 billion pounds in a 10-year Gilt syndication on Tuesday, suggesting investors may be viewing these higher yields as attractive levels to buy. While MUFG doesn't expect any crisis-type scenario in the U.K., the risks from fiscal uncertainty will persist into the budget later in the year and in that scenario, the bank assumes sterling underperformance will continue.

EUR/GBP has quickly retraced the drop triggered by the cautious Bank of England rate cut and MUFG sees scope for further gains ahead -- 0.8769 is the recent intra-day high, which the bak sees being broken.