Britain’s Borrowing Crunch: Highest Bond Yields Since 1998

Britain’s long-term borrowing costs have surged to their highest levels since 1998, posing a significant challenge to Chancellor Rachel Reeves as she seeks to fund public projects. The 30-year gilt yield, effectively the interest rate investors demand to lend money to the government, recently hit 5.22%. This surpasses even the peak seen after Liz Truss’s controversial 2022 “mini budget.”

Graham Watson's insight:

For now, a bit of a watching brief with today's news that the government might be unable to meet one of its borrowing targets as the interest rate on 30 year gilts reached 5.25%. Currently, debt interest repayments are forecast to be equivalent to 7% of GDP, but it seems that this is going to rise because interest rates have gone up.

As a result, further spending cuts are likely Another implication is that is likely to be the case that this threatens future economic growth.

One key driver behind rising yields is stubbornly high inflation, which continues to hover above the Bank of England’s 2% target. Investors increasingly believe the Bank will be slower to cut interest rates than previously thought—especially amid uncertain global economic conditions, including persistent cost pressures following the pandemic and Russia’s invasion of Ukraine. Higher interest rates tend to push up bond yields because investors expect better returns in a world of tight monetary policy.

These higher borrowing costs could erode Reeves’s room for manoeuvre under her own fiscal rules. The government’s fiscal watchdog estimates that a permanent one-percentage-point rise in gilt yields could add £12 billion per year to borrowing costs by 2029/30. Analysts note that this increase risks wiping out most of the £10 billion “buffer” the chancellor kept in reserve at the last budget. If yields stay elevated, Reeves might be forced to consider raising taxes or cutting public spending to avoid breaking her commitment to balance day-to-day spending by 2029/30.

Although some investors, like Aviva Investors, believe gilt yields are set to fall if growth slows and inflation eases, others are more cautious. J.P. Morgan says 10-year gilt yields look relatively cheap compared to U.S. Treasuries but worries about fiscal uncertainty—especially if large-scale bond issuance continues. RBC sees limited scope for yields to climb even higher in the short term unless the market drastically changes its view on the Bank of England’s interest rate cuts.

With an updated economic forecast due in March 2025, Reeves will be under pressure to respond. As the cost of borrowing rises across global markets, the UK’s fiscal outlook remains closely tied to investors’ appetite for government debt—and their belief in Britain’s ability to keep inflation in check.

Glossary of Economics Terms

• Gilt: A UK government bond.
• Yield: The interest rate or return on a bond.
• Fiscal Rule: A government-imposed target to limit spending or borrowing.
• Inflation: General increase in prices and fall in the purchasing value of money.
• Monetary Policy: Central bank actions to control the supply of money and interest rates.
• Bond Issuance: When a government (or company) raises funds by selling bonds to investors.

Key Content From the Video

1. Overview of the Issue:

• UK government bond yields have surged to their highest levels since 1998.
• The 30-year gilt yield recently reached 5.22%, surpassing the peak following the controversial 2022 "mini-budget."
• Rising bond yields pose significant challenges to government fiscal plans.

2. Key Reasons for Rising Bond Yields:

• Persistently High Inflation: Investors demand higher returns to compensate for inflation eroding bond values.
• Interest Rate Expectations: Markets anticipate fewer or smaller interest rate cuts by the Bank of England.
• Fiscal Uncertainty: Concerns about elevated government borrowing plans and debt sustainability.
• Increased Bond Supply: More government borrowing increases bond issuance, leading to lower prices and higher yields.

3. Problems for the Government:

• Increased Borrowing Costs: Higher bond yields raise government interest payments, limiting funds for other priorities.
• Budget Challenges: A permanent 1% rise in gilt yields could add £12 billion annually to borrowing costs by 2029/30.
• Policy Constraints: The Labour government may need to cut spending or raise taxes to meet fiscal rules, potentially undermining public investment and social programs.
• Ripple Effects: Rising bond yields contribute to higher mortgage rates, affecting the housing market and household finances.