UK borrowing costs hit highest level this year as gilt sell-off intensifies

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

A sell-off in UK government bonds intensified on Thursday, as investor worries over additional debt in chancellor Rachel Reeves’ Budget pushed UK borrowing costs to their highest level of the year.

The yield on the 10-year gilt was up 0.09 percentage points to 4.44 per cent, having earlier climbed above 4.50 per cent. The pound fell 0.8 per cent to $1.286 against the US dollar, its lowest in more than two months.

With government bond prices falling, Reeves said that the Labour government’s “number one commitment” was to economic and fiscal stability, insisting on Bloomberg TV that she had put in place robust fiscal rules and that there would be a “significant fiscal consolidation”. 

The moves followed volatile trading on Wednesday, when the bond market responded negatively to a £28bn-a-year increase in borrowing outlined in Labour’s first Budget in 14 years. The Office for Budget Responsibility called it “one of the largest fiscal loosenings of any fiscal event in recent decades”.

Ben Nicholl, a senior fund manager at Royal London Asset Management, said some investors were concerned that assumptions in the Budget were too optimistic and Reeves might have to further raise more debt than anticipated.

“There is a fear, I think, that Labour will have to come back to the bond market in April, to increase borrowing and raise more taxes,” he said.

The Institute for Fiscal Studies on Thursday pointed to the OBR’s costings showing the government’s increase in employers’ national insurance contributions would not raise “anything like” the £25bn estimated by the Treasury, once the knock-on effects on wages and profits were factored in.

Figures from the Debt Management Office also showed debt sales were likely to reach £300bn in the current fiscal year, up from the previous estimate of £278bn and slightly above investors’ expectations.

The rise in yields takes UK 10-year borrowing costs closer to the 4.63 per cent peak hit in the wake of Liz Truss’s September 2022 “mini” Budget, which sparked a crisis in the gilt market and caused the pound to crash to a record low.

However, many other investors played down any parallels, saying that the bulk of the move in markets was down to a shift in expectations of Bank of England interest rates.

“This does not look like a repeat of the market reaction to the 2022 Budget,” said Vivek Paul, UK chief investment strategist at the BlackRock Investment Institute. 

Barclays chief executive CS Venkatakrishnan told the Financial Times that the government had “done an admirable job of balancing spending, borrowing and taxation in order to drive the fundamental objective of growth”.

While some corporate executives slammed the Budget for its massive tax hikes, Venkatakrishnan said: “We can all quibble about little issues. There’s no perfect answer to this.”

The OBR said on Wednesday that the additional borrowing had not been fully expected by investors and was likely to result in higher interest rates over the next few years.

JPMorgan’s Allan Monks said Labour’s decision to “tax, borrow and spend on a large scale” would push up short-term growth and inflation.

He added that the Budget “changes the calculus” for interest rate cuts.

Swaps markets have moved to price in a slower rate of cuts over the coming year. Investors now expect three quarter-point rate reductions over the next 12 months. Before the Budget, they had reckoned on four or five.

UK stocks fell as traders pared back expectations of rate cuts. The FTSE 100 slipped 0.6 per cent. The mid-cap FTSE 250, which is more domestically focused, fell 1.5 per cent, having climbed 0.5 per cent in the previous session.