The UK government's long-term borrowing costs have surged to their highest level since 1998, driven by rising fuel prices and political uncertainty, which are eroding Chancellor Rachel Reeves's fiscal headroom.
Bond Yields Hit 27-Year High
The yield on 30-year UK government bonds, known as gilts, reached 5.77% at lunchtime on Tuesday, up 0.13 percentage points. This exceeds the previous 27-year high recorded last September. Yields have been climbing across major economies due to renewed inflation fears, exacerbated by US efforts to escort ships through the Strait of Hormuz, which prompted Iranian reprisals.
However, the UK has been particularly affected by rising borrowing costs since the onset of the conflict, with some investors attributing this to uncertainty surrounding Prime Minister Keir Starmer's government. Higher borrowing costs are eating into the fiscal headroom that Chancellor Rachel Reeves has built against her fiscal rules in the Office for Budget Responsibility's tax and spending forecasts.
Political Uncertainty Fuels Market Concerns
City analysts have produced a flurry of research notes in recent days, questioning whether Thursday's local elections in England, Scotland, and Wales could signal the end of Starmer's leadership. Potential successors could weaken the government's commitment to fiscal rules, further pushing up borrowing costs.
Luke Hickmore, investment director for bonds at Aberdeen Investments, noted that markets are "actively pricing" the election outcomes. "Politics is not background noise. In today's gilt market, it is a fundamental part of the investment signal," he said.
Two frontrunners, Angela Rayner and Andy Burnham, have indicated a more interventionist economic approach. Thomas Pugh, chief economist at RSM UK, said this is "one reason" gilt yields have risen sharply. "Granted, more debt-funded government spending would, in theory, provide a near-term boost to growth, but it would also boost inflation," he added.
Allies of Burnham, the Greater Manchester mayor, told the Guardian last week that he has a credible plan to return to Westminster "within weeks."
Broader Economic Implications
On Tuesday, UK bond yields moved more than those of other leading economies, partly because London markets were closed for a bank holiday on Monday, delaying the absorption of Middle East developments. Ten-year UK government bond yields also rose by 12 basis points to 5.09%, the highest since late March. Both 10-year and 30-year yields eased slightly later in the afternoon. Bond yields move inversely to prices.
The Bank of England warned of higher-than-expected inflation last week, leaving interest rates on hold at 3.75% but signaling potential action to control price rises. Petrol costs have risen sharply since the war began, and higher energy and fertiliser prices are expected to spread across the economy.
Bank Governor Andrew Bailey stated that "where we go from here will depend on the size and duration of the shock to energy prices." He added, "The longer this problem goes on and the longer the disruption to energy supplies goes on, the more difficult the scenario we're in."
As a significant energy importer, Britain is more exposed to the Middle East inflation shock than other large economies. The International Monetary Fund warned last month that further escalation in the Iran war would affect the UK more than other G7 nations.
Lale Akoner, an analyst at eToro, said markets are "starting to price in a more fragile UK outlook than headline data suggests," citing "a combination of political uncertainty, energy sensitivity and fiscal pressure." She added, "If uncertainty persists, upward pressure on yields is likely to remain, with broader implications for borrowing costs and financial conditions across the economy."
