UK government borrowing costs surged to their highest level in 28 years on Tuesday, as investors bet the Bank of England will raise interest rates as many as five times by November 2027 to bring down stubborn inflation. The yield on 30-year gilts jumped above 5.95 per cent, a level not seen since 1998.
Markets are now pricing in five separate rate increases in little more than a year, taking the Bank's main rate from 3.75 per cent today to 5 per cent by November 2027.
There is a 35 per cent chance that the first of those moves comes as soon as Thursday this week, according to bets on financial markets. That would follow inflation figures due Wednesday that could show the consumer prices index rose above 3 per cent in August, well ahead of the Bank's 2 per cent target.
If the Bank chooses to hold off this week, there is an 80 per cent chance of a hike following the next meeting of its monetary policy committee on November 5. Either way, the prospect spells misery for households with mortgages and for businesses that borrow, coming just days after Chancellor John Healey's first Budget on October 28.
Gilts are bonds issued by the UK government to fund its borrowing, and their yields reflect the interest rate the Treasury must pay to raise money from investors. When yields rise, it becomes more expensive for the government to borrow, and the increase often feeds through into higher mortgage rates and other borrowing costs across the wider economy.
Cost of living pressures build
The rise in borrowing costs raises the prospect of Britons heading into Christmas facing higher taxes and borrowing costs, alongside sharp increases in the price of fuel, energy and food, as conflict in the Middle East pushes up oil and gas prices.
Oil came close to $110 a barrel this week as the war fuelled fears over supplies, pushing petrol pump prices to a four-year high.
Energy bills look set to follow, with Bloomberg Economics forecasting a £427, or 25 per cent, rise in January to £2,150 a year for a typical household. That could push inflation above 4 per cent next year, adding to pressure on the Bank of England to raise rates.
Anthony Brinkman, high yield portfolio manager at Principal Asset Management, said the recent gilt market moves seemed intent on showing central banks they are out of time, with the market expecting action and UK government bonds selling off.
He said the UK was especially vulnerable because of the combination of oil prices at $100 to $110 a barrel and concerns about the credibility of the public finances ahead of the October 28 Budget. He added that Thursday was essential, warning that if the Bank of England does not hike rates and fails to communicate its long-term trajectory convincingly, even two-year yields at 5 per cent may begin to look a little rich.
Global bond market pressures
The two-year gilt yield rose above 4.95 per cent on Tuesday, its highest level since 2023, while the ten-year yield reached a 19-year high above 5.4 per cent.
It is not just a British problem, though yields in the UK are higher than anywhere else in the G7 and much of the developed world.
The yield on ten-year US Treasuries is also at its highest level since 2007, just above 5 per cent, with the US Federal Reserve expected to raise rates on Wednesday.
Japan's ten-year bond yield hit a three-decade high above 3 per cent. In Germany, the ten-year benchmark yield sat near its highest since 2009 at 3.55 per cent, while French ten-year yields hovered near an 18-year high above 4.5 per cent.
Market reaction
Susannah Streeter, chief investment strategist at Wealth Club, said there was no let-up in the volatility rippling through financial markets, with energy prices staying painfully elevated and worries swirling about the knock-on effect for inflation and interest rates.
She said the Middle East conflict had become more entrenched, with Iran clearly in the fight for the long haul, fuelling fresh worries that higher energy costs would become embedded in economies, leaving companies with little choice but to raise prices on a vast range of goods.
Streeter said that would be concentrating the minds of the raft of central bankers meeting this week on both sides of the Atlantic to decide on rate hikes, adding that bond markets were reflecting concerns that the only way is up, and worries that the ascent could be a steep one.
