Long-term UK borrowing costs have climbed to their highest level since 1998, as investors react to the war in Iran, disruptions to global energy supplies, and growing political uncertainty ahead of UK elections.
Government bond markets across major economies have weakened since the US-Israeli conflict with Iran began. As bond prices fall, yields rise, increasing the effective cost of Government borrowing.
The pressure has been felt across the G7, but the UK has seen a sharper market reaction than many comparable economies. Traders have pointed to a mix of global and domestic concerns, including the UK’s sensitivity to inflation, higher expected energy costs and uncertainty around the political outlook.
On 5 May, the yield on 30-year UK Government bonds reached a 28-year high. The yield on 10-year bonds also rose sharply, hitting its highest level for 18 years.
Energy shock drives market pressure
The conflict has led to the effective closure of the Strait of Hormuz, one of the world’s most important routes for oil and liquefied natural gas. That disruption has affected global energy supplies and pushed prices sharply higher.
Markets are now pricing in the possibility that energy costs could remain elevated for longer than previously expected. Higher energy prices feed into inflation, which in turn can make it harder for central banks to cut interest rates.
That has unsettled bond markets. Investors are demanding higher returns to hold Government debt, particularly longer-term debt, where inflation risks can have a larger impact.
At the beginning of May, bond markets weakened further as investors began to assume the Strait of Hormuz blockade could persist for some time. The 30-year UK gilt yield peaked at around 5.78%, while the 10-year yield reached about 5.1%.
UK political risk adds pressure
While global factors have driven much of the market movement, the UK has faced additional pressure due to domestic politics.
There were jitters in Government debt markets ahead of last Thursday’s elections. Labour lost hundreds of council seats, while also facing difficult national elections in Scotland and Wales.
Those concerns have added to investor unease at a time when markets are already sensitive to inflation, borrowing and growth. Traders have suggested the UK is being treated as more vulnerable because its economy is seen as more prone to inflation than some other major economies.
The Government has pointed to stronger growth, lower inflation and improved borrowing figures earlier in the year, before the conflict in Iran escalated. UK Government borrowing fell to a three-year low in the year to March, dropping to £132 billion.
However, analysts expect borrowing to worsen during the year if inflation rises again.
Reeves faces tighter fiscal room
Rising gilt yields matter because they increase the cost of servicing Government debt. That could put more pressure on Chancellor Rachel Reeves as she tries to meet her fiscal rules.
Her two main rules are to avoid borrowing for day-to-day spending by the end of this parliament, and to get Government debt falling as a share of national income over the same period.
Higher debt interest costs make both targets harder to meet. They also reduce the Chancellor’s room for tax cuts, spending increases or other policy measures.
The 30-year gilt is a relatively niche part of the market. It is effectively a 30-year loan to the Government and has historically been bought largely by defined benefit pension funds. The Debt Management Office currently has no active auctions scheduled at this maturity. At last year’s Budget, it also adjusted its borrowing plans to reduce reliance on this type of long-term debt.
Unlike in the US, 30-year bond yields do not directly determine the fixed mortgage rates lenders offer in the UK. Two-year and five-year gilt yields remain elevated, although they are still below their 2023 peaks.
Bank of England governor Andrew Bailey has played down concerns about the gilt market, citing sterling’s strength. He said recent market moves were largely linked to the conflict and related comments, rather than to a clear UK-specific crisis.
Even so, investors are watching both events in the Gulf and the UK political calendar closely. Together, they have created a fragile moment for Government debt markets.
Talk to us about your business.
