The rise in British government bond yields since the release of the Labor government's first budget in October sparked widespread concern last week as borrowing costs rose and broke multi-decade highs.
The prospect of cuts in public spending or further tax increases came into focus 30 years of gold plating Yields reached their highest level since 1998. Although they initially fell following Labor's election victory in July, 2 year gold plating Yields have also climbed back above 4.5%, while the 10-year yield has reached levels not seen since 2008.
Investors' waning confidence in the UK was particularly highlighted by the simultaneous fall in sterling, which hit its lowest level against the US dollar since November 2023 on Friday.
Borrowing costs are also rising in the euro area and the US, and economists point out that the UK is being weighed down by external factors, including the return of Donald Trump to the White House and expectations that interest rates will be much higher this year previously expected.
Still, the rise in UK yields is a major concern for the British government, which has promised to restart economic growth while ensuring debt as a share of the economy falls within five years. The UK public sector's net debt is currently close to 100% of GDP.
“The rise in gilt yields has a self-reinforcing feedback loop on the UK’s debt sustainability by increasing the cost of borrowing used for fiscal purposes,” said Michiel Tukker, senior European rates strategist at ING, in a note on Friday.
Tukker cited an analysis by the independent Office of Budget Responsibility that suggests the recent rise in yields – if sustained – will reduce the government's estimated 9.9 billion pounds ($12.1 billion) of room to comply self-declared budget rules would be destroyed. These rules not only aim to reduce the UK's debt-to-GDP ratio over time, but also require Labor to cover current government spending with revenue.
The Institute for Fiscal Studies think tank said on Friday that there was a knife-edge chance for the UK to implement the latter fiscal rule, but that Finance Minister Rachel Reeves could “get lucky”.
Otherwise, it faces an “unenviable set of options,” said Ben Zaranko, deputy director of the IFS, including bringing forward impending changes to debt calculations to provide more leeway; cutting current spending plans; Announcement of further tax increases that could be subject to changes in the coming years; or do nothing and break their rule.
Economists Ruth Gregory and Hubert de Barochez from research group Capital Economics also said that UK government bonds could be caught in a “vicious circle” in which “the rise in UK yields is putting pressure on public finances and therefore calling for even greater fiscal tightening. “Politics, which in turn represents an additional burden on the economy.
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Pounds vs. Dollars.
Bank of America Global Research strategists said Friday it was unlikely Labor would break their rules and would instead announce further fiscal consolidation – measures to reduce the national debt, generally cuts in government spending or tax increases – in the spring or sooner.
This would potentially come through spending cuts, they added, resulting from the £40bn tax rises Labor announced in October.
A Treasury spokesperson told CNBC: “This administration's commitment to fiscal rules and sound public finances is non-negotiable.”
“The Chancellor has already shown that difficult spending decisions will be made as the spending review to tackle waste is ongoing. And in the coming weeks and months, the Chancellor will leave no stone unturned to achieve economic growth and fight for working people.”
Britain is in the “slow growth trap” – but not a mini-budget crisis
Former British finance minister Vince Cable told CNBC on Friday that many countries were seeing higher bond yields and that it was not an “emergency panic situation” – but that markets had recognized that Britain was in a “slow growth trap.” “stuck.
“We've been there for many years, since the financial crisis, then Brexit, then a problem with Covid and the war in Ukraine, and we're stuck with relatively high inflation and very slow growth, and that's why markets are evaluating that “Relatively speaking, however, this is not a panic situation, it is not a balance of payments sell-off crisis,” Cable said.
Labor should have opted for a broader range of tax increases rather than focusing on a rise in social security, which has been criticized by Britain's business community, Cable said. However, he added that the market had broader concerns about UK growth and the global economic situation, which was clouded by external factors such as the weaker outlook for China.
Revised figures show the UK economy stagnated in the third quarter
Cable also played down comparisons to Britain's mini-budget crisis in 2022, when then-Prime Minister Liz Truss's announcement of sweeping tax cuts sparked massive volatility in the bond market.
“The Truss moment was a prime minister simply taking a reckless leap in the dark and sharply increasing the budget deficit on the assumption that this would somehow trigger economic growth. Well, that clearly didn't happen this time. The dispute is about “whether they tightened enough and whether they did it in the right way, but it's a different issue,” Cable told CNBC.
This sentiment was largely reflected in broader analysis. Bank of America strategists called mini-Budget comparisons “exaggerated” and noted that the hurdle for the Bank of England to intervene in the gilt market, as it did then, is high.
According to Capital Economics, last week's higher Treasury yields were an economic headwind but not a crisis, with smaller and slower moves than after the mini-budget; However, David Brooks, head of policy at consultancy Broadstone, said there did not appear to be any “systemic issues” at play in liability-driven investment (LDI) funds, which were the biggest concern in 2022.
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