UK gilt yields reach highest level since 2008 amid market fears

The yield on 10-year UK government bonds rose to just below 5.3% in early trading on Wednesday, its highest level since mid-2008, as a renewed global bond sell-off increased the UK’s borrowing costs.

The rise adds pressure to John Healey as he prepares the budget scheduled for 28 October. Higher yields increase the cost of financing government debt and could reduce the room available against the government’s fiscal rules.

Why bond markets are under pressure

Investors have been selling government bonds in major markets because of concerns about inflation and rising budget deficits. The renewed exchange of fire between the US and Iran since the weekend has pushed up oil prices and increased expectations that central banks may raise interest rates in the coming months.

The United States launched new airstrikes on Iranian targets overnight, followed by Iranian counterstrikes against American interests in Gulf allies, according to the supplied account. The renewed fighting has added to concerns about further inflationary pressure.

Key points

• Deutsche Bank economists estimate that the £26bn fiscal headroom created by Rachel Reeves at her spring forecast could fall below £14bn by the budget.
• Brent crude oil was trading at about $95 a barrel amid renewed fighting in the Middle East.
• Asian markets also fell: Tokyo’s Nikkei 225 declined 2.85%, China’s CSI 300 lost 1.4% and South Korea’s Kospi dropped 3.3%.

What the move means for the UK budget

UK analysts estimate that the increase in gilt yields since the start of the Iran war may have erased almost half of Healey’s fiscal headroom. If the margin falls below £14bn, he would face a choice between tax increases and spending cuts to rebuild it, while also coming under pressure to fund higher defence spending.

Chris Beauchamp, chief market analyst at IG, said governments globally were under pressure from bond markets and that the situation was especially acute in the UK because of high debt levels and rising borrowing costs.

Markets remain unsettled

Investors have also been rattled by attempts by the US administration to influence financial markets, including helping Japan support the yen and buying back US Treasury bonds to restrain rising yields. Neither measure appeared to have succeeded, according to the supplied account.

What happens next

Healey is due to face these borrowing-cost pressures when the budget takes place on 28 October; if the estimated fiscal margin has narrowed, he would have to consider tax increases or spending cuts to rebuild it.