A global sell-off in government bonds is adding pressure to UK borrowing costs just weeks before Chancellor John Healey delivers next month’s budget, as the yield on 10-year gilts approached a 19-year high.
The gilt yield had risen to 5.38% by mid-morning on Thursday, hovering near the 19-year peak reached last week. Higher interest rates raise the upfront cost of government investment and feed directly into the Office for Budget Responsibility’s assessments of whether the government can meet Labour’s fiscal rules.
Analysts estimate that recent increases in gilt yields have erased more than half of the £24bn “headroom” against those rules that former chancellor Rachel Reeves built up by the spring statement in March. Healey has repeatedly committed to meeting the fiscal framework with a “buffer against uncertainty,” though the expected size of that buffer is widely anticipated to fall well short of the £24bn level. Restoring it would likely necessitate substantial tax increases or spending cuts, according to analysts. Treasury sources said the budget would be “focused,” with some significant spending decisions deferred to a review next year.
The bond selloff has been driven by investor concerns over persistent inflation and the prospect of higher interest rates amid the ongoing conflict in the Middle East. Bank of England chief economist Clare Lombardelli warned in a speech on Thursday that prolonged elevated oil prices raise the risk that UK interest rates may need to rise further.
“The longer higher energy prices persist, the greater the risk that indirect effects build and that inflation expectations, wage bargaining and price-setting behaviour begin to adjust in response,” Lombardelli told an economic conference in Warsaw, Poland. “On that basis, policy is increasingly likely to need to tighten if elevated energy prices persist, absent clear evidence of disinflation or weaker activity.”
Higher rates would increase mortgage costs for homeowners at a time when Prime Minister Andy Burnham’s government has pledged to give consumers “breathing space” against the rising cost of living. The Bank of England is also forecasting a 24% rise in the quarterly energy price cap that determines household utility bills in January, should oil prices remain elevated. Lombardelli’s remarks echoed warnings from Bank governor Andrew Bailey after the monetary policy committee kept rates on hold at 3.75% last week.
While high oil prices have so far had less spillover impact on broader inflation than the Bank had feared, Lombardelli cautioned that the longer they remain elevated, the greater the risk of inflation becoming entrenched.
The bond sell-off extended across Atlantic markets on Thursday, with yields on 30-year US Treasury bonds surging to 5.444% — the highest level since 2004. Alongside inflation concerns, investors are weighing the risks of unchecked US government spending. Some analysts also pointed to large-scale bond issuance by artificial intelligence firms as a factor undermining demand for Treasuries.
