UK long-term borrowing costs near highest level since 1998

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Long-term UK borrowing costs have neared their highest level this century, as worries over the country’s economic outlook combine with a rise in global bond yields stoked by Donald Trump’s battle with the US Federal Reserve.

In a move that intensifies pressure on chancellor Rachel Reeves ahead of her Autumn Budget, the yield on 30-year UK government debt rose as high as 5.64 per cent in early trading on Wednesday — its highest point for four months and just below a level last reached in 1998.

Yields later fell back to 5.61 per cent.

Mark Sobel, a former US Treasury official and US chair of think-tank OMFIF, said that, like other big economies, the UK was “ensnared in a fiscal trap” of anaemic growth and high taxes.

“Large debt and deficits will continue, keeping upward pressure on bond yields,” he added. 

While global bond yields have risen in the wake of Trump’s campaign against the Fed and Germany’s moves to increase debt and spending, gilts have been harder hit than other bonds this month.

Thirty-year gilt yields, which rise as bond prices fall, have increased 0.23 percentage points since the start of August, compared with 0.15 percentage points on German Bunds and 0.07 percentage points for US Treasuries.

If sustained, the recent increases in gilt yields would reduce Reeves’ headroom from £9.9bn as of the Spring Statement to £5.3bn, according to Alex Kerr, an economist at Capital Economics.

Increased debt servicing costs, combined with potential downgrades to growth forecasts by the Office for Budget Responsibility, might force the chancellor to raise as much as £27bn in her Budget to close the hole in the public finances, he added.

Bond fund managers said the UK was facing a growing risk of “stagflation”, where persistent inflation — running at just below 4 per cent — makes it harder for the Bank of England to cut interest rates to support flagging growth.

A move to increase taxes to improve the public finances would be likely to “slow growth further, which could put further pressure on the stagflationary issues that are currently present”, said Robert Dishner, senior portfolio manager at US asset manager Neuberger Berman.

The rise in yields is also putting the BoE under growing pressure to slow down its so-called quantitative tightening (QT) programme to shrink its balance sheet, which had expanded due to huge bond purchases made in past financial crises. 

The bank is reducing its balance sheet by £100bn a year at present, partly through sales that analysts warn are pushing down gilt prices.

Mark Dowding, fixed income chief investment officer at RBC BlueBay Asset Management, said that investors were “concerned with inflation [and] UK policy credibility”. 

He warned that unless the government made spending cuts and the BoE halted QT, “the black hole will keep growing, and the risk is a market tantrum”.

Despite the recent sell-off in longer-term debt, 10-year gilt yields, the most closely watched yardstick for long-term borrowing costs, were at 4.74 per cent on Wednesday, some way below the 16-year intraday high of 4.93 per cent reached in January. 

The pound, which has been a victim of past worries over UK debts, has risen 1.8 per cent so far this month against a weaker dollar. 

“Long-dated bonds almost everywhere have been under pressure,” said Fidelity International fund manager Mike Riddell.

He said gilts had recently underperformed Treasuries “because the Fed has signalled more cuts, while the Bank of England has been hawkish in recent weeks”.

Derivatives markets are pricing in just one quarter-point rate cut by the BoE over the next 12 months, against the four expected from the Fed.