UK government bond yields higher in March since Labor government launched the first budget plan in October sparked widespread concern last week, as borrowing costs rose and broke multiple decade highs.
Prospects for cuts in public spending or further tax increases came into focus last week, as 30-year gilding offers to guess yours the highest level since 1998. Despite an initial decline following Labour’s election victory in July, 2-year golden age yields also returned above 4.5%, while the 10-year yield reached levels not seen since 2008.
Weakening investor confidence in the UK was highlighted by a simultaneous fall in the pound, which hit its lowest level against the US dollar since November 2023 on Friday.
Borrowing costs are also rising in euro area and OURand economists point out that external factors are weighing on the UK, including Donald Trump’s return to the White House and expectations for generally higher interest rates than previously expected this year.
But rising UK yields are still a major headache for the UK government, which has promised restart economic growth while ensuring a reduction of debt as a share of the economy within five years. UK public sector net debt it currently amounts to almost 100% of GDP.
“The rise in gilt yields has a self-reinforcing feedback loop through UK debt sustainability, by increasing borrowing costs used for budgetary purposes,” ING senior European rates strategist Michiel Tukker said in a note on Friday.
Tukker cited analysis by the independent Office for Budget Responsibility showing that the recent rise in yields – if sustained – would wipe out the government’s estimated £9.9 billion ($12.1 billion) of room to meet its self-proclaimed fiscal rules. These regulations oblige Labor to cover day-to-day government spending with revenue, as well as the goal of moving towards reducing the UK’s debt-to-GDP ratio over a longer time frame.
The Institute for Fiscal Studies think tank said on Friday there was a “knife-edge” chance of the UK reaching the previous fiscal rule, but that Chancellor Rachel Reeves could “get lucky”.
Otherwise, it faces an “unenviable array of options,” IFS associate director Ben Zaranko said, including bringing forward the upcoming changes in the way debt is calculated to free up more space by cutting current spending plans and announcing additional tax increases, which could be subject to changes in the coming years. The minister could also choose to do nothing and break her own rule.
Economists Ruth Gregory and Hubert de Barochez of research group Capital Economics also said British gilts could be trapped in a “vicious cycle” in which “rising UK yields are straining public finances, so they are calling for even more fiscal tightening policy, but in turn further burdens the economy.”
The pound against the dollar.
Bank of America Global Research strategists said on Friday that Labor was unlikely to break its rules and instead announce further fiscal consolidation — measures to reduce public debt, generally cut public spending or raise taxes — in the spring or earlier.
This could potentially be achieved by reducing spending, they added £40bn of tax increases which Labor announced in October.
A Treasury spokesman told CNBC: “This government’s commitment to fiscal rules and sound public finances is non-negotiable.”
“The Chancellor has already shown that tough spending decisions will be made, with spending being reviewed to root out waste. And over the coming weeks and months, the Chancellor will leave no stone unturned in her determination to deliver economic growth and fight for working people.”
UK in a ‘slow growth trap’ — but not a mini budget crisis
Former British Chancellor of the Exchequer Vince Cable told CNBC on Friday that higher bond yields were being seen in many countries and that this was not a “panic emergency” – but that markets had realized Britain was stuck in a “slow growth trap”.
“We have been there for many years, since the financial crisis, then Brexit, then the problem with Covid (-19) and the war in Ukraine, and we are stuck with relatively high inflation, very slow growth, so the markets Relatively speaking, this is not a panic situation, it’s not an old-style balance-of-payments sell-off crisis,” Cable said.
Labor should have opted for a wider range of tax rises instead of focusing on an increase in national insurance – payroll tax – which criticized by the British business communityCable said. However, he added that the market had broader concerns about UK growth and the global economic picture, which was clouded by external factors such as China’s weaker outlook.
Cable also played down comparisons with UK Mini Budget Crisis 2022when then-Prime Minister Liz Truss’s announcement of across-the-board tax cuts caused major volatility in the bond market.
“The Truss moment was a prime minister who simply took a reckless leap into the dark with a big increase in the budget deficit on the assumption that it would somehow trigger economic growth. Well, that clearly hasn’t happened this time. The argument is whether they did enough tightening and whether they did it the right way, but that’s a different kind of problem,” Cable told CNBC.
This sentiment was widely reflected in the broader analysis. Bank of America strategists called comparisons to the mini-budget “overblown,” noting that the bar for the Bank of England to intervene in the gold market, as it did at the time, was high.
Capital Economics said last week’s higher gilt yields were an economic tailwind but not a crisis, with smaller and slower moves than after the mini-budget. David Brooks, head of policy at consultancy Broadstone, said there did not appear to be any “systemic issues at play” in liability-led investment funds (LDI), which were the biggest concern in 2022.