By William Schomberg
LONDON (Reuters) – Britain’s government borrowing costs have surged this week, complicating Finance Minister Rachel Reeves’ plans to sell bonds worth hundreds of billions to fund public services and investments for growth.
WHAT IS GOING ON IN BOND MARKETS?
The yield on 30-year British gilts shot up sharply on Tuesday and Wednesday, surpassing other governments’ bonds, reaching its highest level since August 1998 at 5.383%. The value of the pound also decreased.
Rising yields indicate that bond investors are demanding a higher return for risk, which typically would strengthen the pound.
Concerns about high borrowing and persistent inflation in Britain, alongside expected inflationary pressures from President-elect Donald Trump’s policies, are worrying markets. Specifically, 30-year U.S. bond yields rose to their peak in over a year during this period.
The pressure on UK yields is heightened by the Bank of England’s hesitance regarding interest rate cuts in light of inflation exceeding targets.
Though the movements in gilt yields and sterling have been pronounced, they are not as extreme as those seen during the 2022 “mini-budget” crisis under former Prime Minister Liz Truss.
WHAT HAS THE UK GOVERNMENT DONE?
Prime Minister Keir Starmer, who returned the Labour Party to power last July, and Reeves announced in their first budget on October 30 that they would borrow nearly £142 billion more over the next five years than previously set out. At present, the UK has £2.8 trillion ($3.5 trillion) in public debt, approximately 100% of GDP – a rise from around 35% before the 2007-08 financial crisis, exacerbated by COVID-19 lockdowns. Consequently, the government’s annual debt interest bill has doubled as a proportion of GDP since the pandemic began. Besides borrowing more, the new government is enforcing tax increases on employers, impacting hiring and investment plans.
WHAT CAN RACHEL REEVES DO ABOUT IT?
Reeves has committed to balancing public services spending with tax revenues by the decade’s end. However, economists suggest the recent spikes in borrowing costs coupled with a stagnant economy since mid-2024 may lead forecasters to conclude she is falling behind. To correct the course, Reeves could either raise taxes or implement potential spending cuts for the late 2020s, even if she does not have to follow through. However, she must avoid alarming investors already concerned about Britain’s debt levels. The next official fiscal forecasts are expected on March 26, during Reeves’ budget update speech to parliament.
WHAT SPENDING PRESSURES DOES THE GOVERNMENT FACE?
Reeves and Starmer assert that the tax increases and heightened borrowing will fund enhancements in public services and bolster infrastructure investments to accelerate future economic growth. They are, however, under pressure to increase spending across various sectors, including health and education, as well as defense. Meeting the defense spending demand – proposed by Trump for U.S. allies – to rise from 2.3% to 2.5% of GDP by the decade’s end could incur an annual cost of around £6 billion, equivalent to the entire current annual investment budget for education.
WHAT’S LIKELY TO HAPPEN NEXT?
Investors are keenly observing whether Trump, who assumes office on January 20, will realize his threat to impose hefty tariffs on imports. While Trump hasn’t explicitly mentioned Britain facing such duties, these could escalate U.S. inflation, subsequently raising yields on Treasuries and likely gilts sensitive to U.S. borrowing costs. CNN noted that Trump was considering declaring a national economic emergency to facilitate tariffs. Any significant tax cuts or increased public spending by Trump could also have inflationary effects on the U.S. For the UK, the pace of interest rate cuts by the Bank of England is crucial for gilt yields. Markets are anticipating two quarter-point cuts for this year, whereas most economists predict four cuts, which would likely lead to a decrease in gilt yields.
($1 = 0.8035 pounds)
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