UK debt burden as borrowing costs rise again amid fresh market turmoil

UK borrowing costs peaked yesterday after the Budget

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

Meanwhile, an auction of new ten-year government bonds attracted the weakest demand since December, with bids covering the £3.75 billion on offer by 2.81 times.

Investors are concerned about Chancellor Rachel Reeves’ £162bn borrowing to fund her spending pledges – which is expected to add to inflationary pressures.

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

The sheer volume of bond issuance in the market also weighs on the price.

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

Experts warned that the rise in government bond yields could jeopardize the chancellor’s plans to rebalance the balance sheet as it would add billions to the cost of paying interest on the government’s pile of debt .

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

Richard Hughes, chairman of the Office for Budget Responsibility (OBR), told the Commons Treasury committee yesterday: ‘We expected the government bond market to be a little surprised.’

The OBR had predicted that the budget would cause a quarter of a percentage point increase in interest rates. He said where they settled was “largely in line with that expectation, maybe a little above that, but not significantly.”

But after he spoke, yields rose further.

Julian Jessop, economics fellow at the Institute for Economic Affairs (IEA), pointed out that interest rates on five-year government bonds are 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, the highest level in five years. “Of course a lot can happen between now and 2028,” Jessop said. “But the early signs are not encouraging.”

Yields on UK bonds are rising faster than those on their US and German equivalents.

The premium charged by investors for buying government bonds instead of German government bonds grew yesterday to 2.14 percentage points, the highest since September 2023.

Analysts at Deutsche Bank said: ‘Following the budget, government bond yields have risen. Expectations for short-term interest rates have increased.

‘Higher interest costs have effectively added a further £5 billion in debt service costs to the Chancellor’s bill, further eroding her budgetary space.’