UK debt woes as borrowing costs rise again amid fresh market jitters

UK borrowing costs hit a post-Budget high yesterday

Yields on British 10-year bonds – known as gilts – surpassed levels seen last week to hit a new one-year high of 4.541 percent.

Meanwhile, an auction of new ten-year bonds attracted the weakest demand since December, with bids covering the £3.75bn bid 2.81 times.

Investors are worried about Chancellor Rachel Reeves’ £162bn overborrowing to fund her spending promises, which is expected to increase inflationary pressures.

This has pushed back expectations about how quickly the Bank of England will cut interest rates, resulting in a sell-off in bonds, whose yields rise as their prices fall.

The magnitude of bond issuance hitting the market is also weighing on the price.

The Bank is expected to cut rates by a quarter of a percentage point tomorrow and markets will be watching for clues about its next move.

Experts have warned that rising bond yields could jeopardize the Chancellor’s plans to balance the books because it will add billions to the cost of paying interest on the Government’s debt.

Some of this was planned, but the bond market fallout so far has been worse than expected.

Richard Hughes, chairman of the Office for Budget Responsibility (OBR), told the House of Commons Treasury select committee yesterday: “We expected the gold market to be a bit surprised.”

The OBR had predicted that the budget would lead to a quarter of a percentage point increase in returns. He said where they had settled was “broadly in line with that expectation, maybe a little above it, but not significantly so.”

But after he spoke, the returns increased even more.

Julian Jessop, economics fellow at the Institute of Economic Affairs (IEA), said five-year bond yields were expected to average 3.6 percent in the fourth quarter of this year and 4 percent between 2025 and 2028.

But yesterday they were trading at more than 4.4 percent, a five-year high. “Of course, a lot could still happen between now and 2028,” Jessop said. “But the first signs are not encouraging.”

UK bond yields are rising faster than their US and German equivalents.

The premium charged by investors for buying gilts instead of German bunds rose yesterday to 2.14 percentage points, the highest since September 2023.

Analysts at Deutsche Bank said: ‘In the wake of the budget, bond yields have risen. Expectations about short-term interest rates have picked up.

“Higher interest costs have effectively added another £5 billion in debt servicing costs to the Chancellor’s bill, further eating into her fiscal space.”