Britain's borrowing costs hit a 27-year high

The yield on British 30-year government bonds has risen above 5.47 per cent, its highest in twenty-seven years, and the Treasury in Whitehall has noticed. International investors are asking for a bigger risk premium because UK inflation will not go away, the government needs to borrow more and it has very little room left under its own budget rules.

From budget to sell-off

The pressure has been building since Rachel Reeves’s first budget in October. It raised taxes by about £40 billion a year, mostly through higher employer national insurance, but it also changed the debt rule so that more borrowing for investment would be allowed, and gilt issuance plans rose accordingly. The Bank of England has cut its policy rate twice since the summer, to 4.75 per cent, while continuing to shrink its gilt holdings, including by selling some outright. The market therefore has to absorb heavy new supply without the central bank as a buyer, just as inflation has crept back above its target.

Each half-point costs £5 billion

Gilt yields feed straight into the government’s fiscal plans. Its rules require debt to be forecast to fall as a share of GDP within five years. Every 50-basis-point rise in gilt yields wipes out roughly £5 billion of that projected headroom, because debt interest goes up. With 30-year yields stuck above five per cent, the capital investment Chancellor Rachel Reeves has planned is being squeezed by the growing bill for existing debt.

The arithmetic works through the Office for Budget Responsibility. Its forecasts use market expectations for gilt yields and Bank Rate in the weeks before each fiscal event, so a rise in yields now shows up directly in projected interest costs when the OBR next reports in the spring. Britain is also unusually exposed because roughly a quarter of its gilts are index-linked, so their coupons rise with inflation as well as with market rates. The headroom the OBR identified in October was thin by historical standards, and the recent move in yields has probably erased most of it.

A slow squeeze this time

This is different from the LDI liquidity crisis of 2022. There is no sudden forced selling by leveraged funds, only a slow, grinding loss of investor confidence. High sterling yields are not enough to keep foreign buyers when Britain still runs a large current account deficit. The clearest sign is the currency: sterling has fallen alongside gilts, an unusual combination for a rich economy, and one that points to worries about fiscal credibility rather than about growth.

That is also why a repeat of the 2022 spiral is unlikely. After the crisis, regulators required liability-driven investment funds to hold enough liquid collateral to withstand a sudden rise in gilt yields of 250 basis points, far more than they held in the autumn of 2022. Funds can therefore meet margin calls without dumping long gilts, so the selling that feeds on itself is missing this time. What remains is the ordinary pressure on a large borrower that relies on buyers who can go elsewhere.

The longer memory is 1976, when a sterling crisis forced a Labour government to borrow from the International Monetary Fund and accept spending cuts as the price. Nothing so dramatic is in prospect now. Britain has a floating currency, an independent central bank and long-dated debt, all of which give it time that it lacked then. The comparison is still useful for one reason: it shows how quickly a government’s room to choose its own fiscal path can shrink once foreign lenders start to hesitate.

Who loses from dearer gilts

Mortgage borrowers are the first domestic casualties. British fixed-rate mortgages are priced off swap rates, which have risen with gilts, so households coming off cheap two- and five-year deals face higher payments even though the Bank has been cutting. Local authorities and housing associations that borrow at spreads over gilts also pay more. Defined-benefit pension schemes, by contrast, gain from higher yields because their liabilities shrink faster than their assets, and savers buying annuities are getting the best rates in a generation.

Why investment gets cut first

If the headroom disappears, the choice of what to cut is shaped by politics. Day-to-day spending on the health service, schools and defence is hard to reduce after a budget that promised to protect it, and the government has ruled out raising the main rates of income tax, employee national insurance and VAT. Capital budgets are the easiest target because the damage from delayed projects shows up years later. Britain followed that pattern after 2010, when public investment was cut early in the austerity programme, and it explains why the Treasury watches every move in long gilt yields.

Not all of it is British

The strongest counterargument is that the sell-off is largely imported. American Treasury yields have risen on the same days, driven by strong economic data and worries about Washington’s deficits, and gilts have long tracked Treasuries closely. On that reading, Britain is paying a modest local premium on top of a global move, and the fiscal rules will be judged on the whole path of yields over the coming months rather than on one bad week. That argument holds for the direction of travel, but it does not explain why sterling has fallen at the same time, and that is how a market signals doubt about a country’s own policy.

What decides the next move

The near-term signals are this week’s December inflation figures, the Bank’s rate decision in early February and the OBR’s spring forecast. A soft inflation print would give the Bank room to cut and pull short yields down, while a firm one would keep the pressure on. The gilt market has set a limit on the government’s borrowing. With long rates near five-and-a-half per cent, Reeves will probably have to trim her investment plans or raise taxes again before the year is out, and the spring forecast is the most likely moment for spending restraint to be announced.