Governments around the world are uneasily watching rising borrowing costs, following the lead of the US Treasury market. But even in a context of global bond debacle, Britain stands out.
British government bonds, known as gilts, are experiencing a particularly hard sell-off as investors recoil from the country’s low economic growth, persistent inflation and high debt levels. The yield on 10-year gilts, the benchmark rate, hit 4.9% on Tuesday, the highest since 2008, while 30-year bond yields were the highest since 1998.
The surge in borrowing costs puts at risk the British government’s plan to revive economic growth by allocating more money for public services and greater investment, less than three months after its announcement.
“At a time when yields are rising everywhere, global investors are looking at the UK as the weakest link in the chain,” said Hugh Gimber, strategist at JP Morgan Asset Management.
And it’s not just bonds. The British pound is at its lowest level against the dollar in more than a year, performing worse than other major currencies over the past month, and stocks have fallen in London.
Gilts and government bonds from other countries followed Treasury yields higher. Since the US presidential election, borrowing costs have risen as fiscal discipline-minded investors expect President-elect Donald J. Trump to adopt policies that will lead to higher inflation, while subsequent robust labor market reports have Expectations of interest rate cuts from the Federal Reserve also decreased.
While the UK government is not directly responsible for rising borrowing costs, it will need to address the implications for its economic plans.
At the end of October, Rachel Reeves, Chancellor of the Exchequer, appeared in Parliament to present the Labor Party’s first budget in 14 years. He announced an annual increase in public spending of 70 billion pounds ($85 billion) over the next five years, half of which will be paid for with higher taxes and the other half through borrowing. It also said it would stick to tough fiscal rules that would lower debt levels.
The move was seen as a gamble, a decision to spend a lot of public money in the short term, encourage investment and hope it leads to greater economic growth that would improve the country’s debt load and avoid having to significantly raise taxes again .
But sooner than expected, this plan will be put to the test. Rising bond yields have made debt repayment more expensive, wiping out the cushion for Ms. Reeves’ fiscal rules.
“We have clear fiscal rules and we will stick to those fiscal rules,” Keir Starmer, the prime minister, said on Monday.
If that persists until March, when the Office for Budget Responsibility, an independent watchdog, releases its half-yearly economic forecasts, Ms. Reeves will have to decide whether to raise taxes further or cut spending to comply with her rules.
“We have a government that is faced with some tough choices,” JP Morgan Asset Management’s Gimber said, as he ruled out raising taxes again and it would be difficult to cut spending at government departments that are already under pressure. “Therefore, global investors are forced to look at the mix of growth and inflation and demand more compensation from UK gilts,” he said.
The desires of global investors are particularly relevant for Britain as around a third of its government bonds are owned by foreign investors.
The implications of the bond market turmoil are fresh in British minds. In late 2022, the government of then Prime Minister Liz Truss announced an aggressive plan to cut taxes and increase borrowing, sidelining fiscal control in the process. Bond yields skyrocketed, the pound collapsed, the central bank had to intervene to stabilize markets and within weeks Mrs Truss was ousted. Fears of a repeat persist, emboldening the Labor Party to insist it will govern with ironclad fiscal discipline.
“This is very different from the 2022 market scenario,” Gimber said. “That was a period where gilt yields really drove global bond yields higher. This time, gilt yields are caught up in a move in global bond yields.”
However, there are few signs of relief. Data released on Wednesday is expected to show inflation will stand at 2.6%, well above the Bank of England’s 2% target. Traders are betting that the central bank will cut interest rates only once this year.
This will keep pressure on the government to respond with fiscal plans that calm markets without abandoning its economic strategy.
Changing the budget would seem “politically weak,” said Benjamin Caswell, an economist at the National Institute of Economic and Social Research. These policies are still new, he added, and many of them won’t be implemented until April at the earliest, so they need time to work in the economy.
“It depends on whether they have the political capital and the will to pull it off,” he said.