The UK government’s long-term borrowing costs have reached the highest level since 1998 amid investor concerns over Britain’s sluggish growth prospects and stubbornly high inflation.
The yield – in effect the interest rate – on UK 30-year government debt rose by as much as four basis points to 5.22% on Tuesday, above the peak reached after Liz Truss’s mini-budget in 2022 caused turmoil in financial markets, to hit the highest level in 27 years.
Long-term borrowing costs have risen across advanced economies amid growing concern that lingering inflation could prevent deeper interest rate cuts by the world’s most powerful central banks. Investors also fear the president-elect Donald Trump’s policies could further stoke inflationary pressures.
Britain’s economy has suffered a sharp slowdown in recent months, leading investors to warn that weak growth, sticky inflation and higher for longer borrowing costs could force the chancellor, Rachel Reeves, to U-turn on pledges not to further increase taxes.
“That 30-year gilts are above 5% is headline news on any measure. But do we think the central bank has lost control of the gilt market at this level? No,” said Nuwan Goonetilleke, the head of capital markets at the FTSE 100 insurer Phoenix Group.
“We’ve got the narrative that inflation has become more persistent. Rate cuts are still expected, but not as quickly, and you have this point about government borrowing being higher.”
The rise in long-term borrowing costs came as the Treasury’s Debt Management Office sold £2.25bn of new 30-year bonds at a yield of 5.2%, the highest level for a 30-year gilt yield since May 1998 when Gordon Brown was the chancellor. At that time, UK interest rates were cut sharply in response to the fallout from the Asian currency crisis and a Russian debt default.
Alongside a delicate economic outlook, investors face the prospect of the Treasury selling about £300bn of bonds this year to refinance maturing debts and to cover the government’s budget deficit. The Bank of England is also selling gilts as it winds down its financial crisis-era quantitative easing scheme. This reverses its position of recent years, when it had been among the largest buyers.
“The market is still giving credibility to the government’s plans. However, it is giving some signs of an amber warning – telling the government to be wary about how far they stretch some of these plans,” Goonetilleke said.
The Office for Budget Responsibility, the Treasury’s independent economic forecaster, has predicted government borrowing will be almost £130bn in this financial year.
Interest rates remaining higher for longer could erase much of Reeves’s £10bn of headroom she left against her main fiscal rule to get Britain’s national debt falling as a share of the economy in the fifth year of forecasts.
The chancellor has said she would not raise taxes to meet her rule, insisting that government spending would instead need to “live within the means that we’ve set out” – raising the prospect of spending cuts when she announces her spring statement on 26 March.
“The margin at five years is pretty wafer thin; it wouldn’t take much of lower GDP growth, higher gilt yields, or above forecast inflation for the government to miss it,” said Philip Shaw, the chief economist at Investec.
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“It’s pretty unlikely the government will cut spending, so Reeves could be faced with the choice between doing nothing and raising taxes. And that’s difficult.”
The Bank had forecast zero growth in the UK economy in the final three months of 2024 and has warned inflation is set to remain above its 2% target until at least 2027. The economy shrank for a second month in October, while revised figures show zero growth in the third quarter.
Investors have pared their bets for deeper rate cuts from the central bank, with financial markets now anticipating only two reductions in 2025, compared with as many as four a couple of months ago.
US 10-year bond yields rose to an eight-month high on Tuesday amid investor concerns over Trump’s policies and ahead of a Treasury auction of $39bn (£31.2bn) of new debt.
Eurozone borrowing costs have also risen after figures this week showed inflation jumped to 2.4% in December, dampening expectations for a bumper rate cut from the European Central Bank later this month.