The UK government's borrowing costs have climbed to their highest level since the 2008 financial crisis, as a sharp rise in oil prices triggered a sell-off in British debt due to inflation fears. The yield on the 10-year gilt, the benchmark for long-term borrowing, rose above five per cent for only the third time since the Iran war began, highlighting Britain's unique exposure to the ongoing energy shock.
UK leads developed economies in borrowing cost increases
Over the past two months, the UK has seen the largest rise in government borrowing costs among developed economies, particularly at the short end of the yield curve. The two-year gilt yield has increased by more than a full percentage point since March, as traders drastically reduced expectations for Bank of England rate cuts this year. As the war continues, the sell-off has extended to longer-dated bonds, reflecting fears that the UK will struggle to insulate itself from future economic shocks, compounding bond market concerns about growth prospects and fiscal management.
Analysts warn of policy errors and energy dependence
Analysts have warned that a series of policy mistakes and the UK's reliance on oil and gas imports make the economy especially vulnerable to external shocks. Higher energy imports will exacerbate already elevated prices, widening the gap between UK and US borrowing costs. The spread between the 10-year gilt yield and the US Treasury yield has reached 70 basis points for only the second time since late 2025.
Kallum Pickering, chief economist at Peel Hunt, noted: "Over the past decade, the UK economy has suffered a succession of policy mistakes and resulting rates of inflation which have consistently exceeded trends across other major economies. Unsurprisingly, it no longer takes much to spook UK government debt markets."
Stubborn inflation and fiscal concerns
The Bank of England has struggled to control inflation as effectively as other central banks since Russia's invasion of Ukraine and the 2022 mini-Budget pushed inflation into double digits. Persistent inflation erodes the real returns from bonds, a major concern for investors. Before the war, inflation was expected to ease after three years above the Bank's two per cent target, and strong borrowing figures from record tax receipts had eased concerns about public finances.
However, these positive developments were derailed by the Iran war and its impact on oil prices. On Tuesday, Brent crude traded above $111, its highest since the war began on 28 February, after US-Iran ceasefire talks collapsed.
Kathleen Brooks, research director at XTB, commented: "Yields are likely to creep higher as we lead up to the key central bank meetings this week, and as we wait to hear what happens next in the Strait of Hormuz."
