Government borrowing costs in the United Kingdom surged last week as part of a global rise in bond yields, hitting Britain harder than any other major economy because it already pays more than any of its peers to fund its debt, economist Hamish McRae has warned.
The yield, or effective interest rate, on ten-year gilts, as UK government bonds are known, stood at just over 5.1 per cent on Monday. It climbed to 5.4 per cent by Thursday evening in New York trading before easing back slightly on Friday.
The rise has already fed through to household borrowing costs. Mortgage rates have started climbing again, with the average five-year fixed rate now at 5.71 per cent, McRae wrote.
The jump in borrowing costs comes as Chancellor John Healey prepares his Budget.
McRae described the move as one more twist in a continuing and troubling story, one that is troubling, he said, because governments, and Britain's in particular, have little understanding of what is coming.
How long will yields keep rising?
The UK is six years into the current bear market for bonds. In terms of yields, the bottom came in 2020, when ten-year gilts yielded just 0.25 per cent, a period so extreme that some banking institutions bought German government bonds at negative yields, effectively paying to lend Berlin money.
McRae said he could not see the upward trend in yields reversing until a "cathartic event", such as a global recession or another surge in inflation, forced the world's central banks to raise interest rates far beyond today's level. Either way, he said, it would not be pleasant.
What counts as a normal yield?
Looking back to the 19th century, when there was effectively no inflation and prices in 1900 were lower than in 1800, the nominal yield on gilts for most of that period ranged from 2.5 to 4.5 per cent. Because there was no inflation, that was also the real yield.
Chris Watling, of the consultancy Longview Economics, said that adding the Bank of England's inflation target of 2 per cent to that historic range produces a figure of 4.5 to 6.5 per cent. With markets now expecting inflation to average at least 3 per cent over the next decade, McRae said the real range looked more like 5.5 to 7.5 per cent.
UK's mounting debt bill
The UK's national debt appears to have passed £3 trillion in August, having stood at £2,985 billion in July; an official update is due next week.
Debt interest already costs the UK more than £110 billion a year, the third largest area of public spending after social security, which includes pensions, and the NHS. McRae said that if ten-year gilt yields rose to 7 per cent, which he described as perfectly possible, it would blow a huge hole in the government's finances.
The picture is complicated further by the fact that a quarter of the national debt is linked to the Retail Prices Index, which typically runs higher than the Consumer Prices Index measure of inflation. On McRae's own rough calculation, the £110 billion interest bill could rise to £140 billion or £150 billion by 2030.
A global problem, worse for Britain
Other countries face similar pressures, McRae noted, with the numbers in some cases, including the United States, looking even more alarming. It was a surge in US bond yields last week that helped drive UK yields higher.
But McRae said the situation is worse for Britain because its government has such a poor reputation among potential investors.
Echoes of 1976
McRae said it all felt uncomfortably like the autumn of 1976, fifty years ago, when the then-Chancellor, Denis Healey, faced a run on the pound and had to apply for a bailout from the International Monetary Fund.
Healey famously turned back at Heathrow Airport to calm the markets instead of continuing to an IMF meeting in the Philippines, an event McRae said he remembers well, as he was on the same plane heading out to report on the meeting.
Reflecting on what might happen next, McRae recalled an exchange from Ernest Hemingway's novel The Sun Also Rises, in which Bill Gorton asks Mike Campbell how he went bankrupt. "Two ways," Mike replies. "Gradually and then suddenly."
The bond market turmoil was also the subject of an episode of the This is Money Podcast, in which Georgie Frost, Helen Crane and Simon Lambert discussed why the UK pays more to borrow than comparable countries and what the bond blowout means for the Budget.
