Governments around the world are watching uneasily as their borrowing costs rise, following the lead of the US government bond market. But even in the global bond rout, Britain stands out.
British government bonds, known as gilts, are suffering a particularly sharp sell-off as investors recoil from the country’s low economic growth, stubborn inflation and high debt levels. The yield on 10-year bonds, the benchmark rate, reached 4.9 percent on Tuesday, the highest since 2008, while yields on 30-year bonds were the highest since 1998.
A sharp rise in borrowing costs is putting at risk the British government’s plan to revive economic growth by spending more money on public services and more investment, less than three months after it was announced.
“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, underperforming other major currencies in the past month, and shares fell in London.
Gilts and government bonds of other countries record higher yields than government bonds. Since the US presidential election, borrowing costs have risen as investors wary of fiscal discipline expect President-elect Donald J. Trump to enact policies that will lead to higher inflation, while a succession of strong labor market reports have also dampened expectations for a contraction interest by the Federal Reserve.
Although the UK government is not directly responsible for the rise in borrowing costs, it will face implications for its economic plans.
At the end of October, Rachel Reeves, Chancellor of the Exchequer, stood in Parliament to present Labour’s first budget in 14 years. It has announced an increase in public spending of 70 billion pounds ($85 billion) a year over the next five years, roughly half of which will be paid for through higher taxes and the other half through borrowing. She also said she would stick to strict fiscal rules that would reduce debt levels.
The move was seen as a gamble, a decision to spend a lot of public money in the short term, spur investment and hopefully lead to higher economic growth that would reduce the country’s debt and avoid another significant tax increase.
But sooner than expected, this plan was put to the test. Rising bond yields have made debt service more expensive, erasing the buffer 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 this continues until March, when the Office for Budget Responsibility, an independent watchdog, releases its semi-annual economic forecasts, Ms Reeves will have to decide whether to raise taxes further or cut spending to comply with her rules.
“You have a government that has been left with some difficult choices,” said Mr. Gimber of JP Morgan Asset Management, as she has ruled out another tax hike and it would be difficult to reduce spending by already overburdened government departments. “Therefore, global investors are left to watch the combination of growth and inflation and demand higher compensation from UK plantations,” he said.
The wishes of global investors are particularly important to Britain as around a third of its government bonds are owned by foreign investors.
The implications of the bond market turmoil are fresh in the minds of Britons. In late 2022, the government of then-prime minister Liz Truss announced an aggressive plan to cut taxes and increase borrowing, removing the fiscal watchdog in the process. Bond yields shot up, the pound fell, the central bank had to intervene to stabilize the markets and within weeks Mrs Truss was sacked. Fears of a repeat have lingered, encouraging the Labor Party to insist it will govern with iron fiscal discipline.
“This is very different from the 2022 market scenario,” said Mr. Gimber. “That was a period where gilt bond yields were really driving global bond yields higher. This time, gilt yields are caught up in the global movement in bond yields.”
Still, there are few signs of relief. Data released on Wednesday is expected to show that inflation will remain at 2.6 percent, well above the Bank of England’s 2 percent 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 look “politically weak,” said Benjamin Caswell, an economist at the National Institute for Economic and Social Research. These policies are still new, he added, and many of them won’t be enacted until April, so they need time to work in the economy.
“It depends on whether they have the political capital and the will to use it,” he said.
