The UK government’s long-term borrowing costs have hit their highest level since 1998, amid rising fuel prices and concerns about political stability.
The yield – effectively the interest rate – on 30-year UK government bonds (gilts) hit 5.77% at lunchtime on Tuesday, up 0.13 percentage points – exceeding the 27-year high reached last September.
Yields have been increasing across leading economies amid renewed fears over rising inflation, after US efforts to escort ships through the strait of Hormuz prompted Iranian reprisals.
But the UK has been hit particularly hard by higher borrowing costs since the onset of the conflict – with some investors blaming uncertainty about the outlook for Keir Starmer’s government.
Higher government borrowing costs will eat away at the headroom the chancellor, Rachel Reeves, has built up against her fiscal rules, in the Office for Budget Responsibility’s forecasts for tax and spending.
City analysts have produced a flurry of research notes in recent days about whether Thursday’s local elections in England and Scottish and Welsh elections could augur the end for Starmer’s leadership – and what potential successors may mean for tax and spending policy.
Luke Hickmore, the investment director for bonds at Aberdeen Investments, said markets were “actively pricing” what the outcome of the elections could mean. “Politics is not background noise. In today’s gilt market, it is a fundamental part of the investment signal,” he said.
Analysts suggested that, should Starmer be forced out of Downing Street, his possible replacements could weaken the government’s commitments to its fiscal rules, which could push up borrowing costs further.
Two of the frontrunners, Angela Rayner and Andy Burnham, have indicated that they would take a more interventionist approach to the economy.
That is “one reason” gilt yields have risen sharply, said Thomas Pugh, the chief economist at the consultancy RSM UK. “Granted, more debt-funded government spending would, in theory, provide a near-term boost to growth, but it would also boost inflation.”
Allies of Burnham, the Greater Manchester mayor, told the Guardian last week that he had a credible plan to return to Westminster “within weeks”.
UK bond yields moved more than those of other leading economies on Tuesday, although London markets were closed for a bank holiday on Monday, so had not had time to absorb developments in the Middle East.
Ten-year UK government bond yields also rose, by 12 basis points or 0.12 of a percentage point, to 5.09% – the highest level since late March.
The yields on both 10-year and 30-year bonds eased slightly later on Tuesday afternoon. Bond yields move inversely to prices.
The Bank of England warned of higher than expected inflation last week, as it left interest rates on hold at 3.75%, but warned it may need to take action to bring price rises under control in the coming months.
Petrol costs have already risen sharply since the start of the war, and higher energy and fertiliser prices are expected to spread to the wider economy in the coming months.
Andrew Bailey, the Bank’s governor, said last week that “where we go from here will depend on the size and duration of the shock to energy prices” as the conflict in the war evolves.
He added: “The longer this problem goes on and the longer the disruption to energy supplies goes on, the more difficult the scenario we’re in.”
As a significant importer of energy Britain is more exposed to the Middle East inflation shock than other large economies. The International Monetary Fund warned last month that a further escalation in the Iran war would affect the UK more than other G7 nations.
Markets were “starting to price in a more fragile UK outlook than headline data suggests”, added Lale Akoner, an analyst at the trading firm eToro, citing the “combination of political uncertainty, energy sensitivity and fiscal pressure”.
“If uncertainty persists, upward pressure on yields is likely to remain, with broader implications for borrowing costs and financial conditions across the economy.”
