Gilts Sell Off As Investors Turn Cautious
UK government borrowing costs rose sharply on Tuesday as financial markets reacted to uncertainty over the future of Prime Minister Sir Keir Starmer. The effective interest rate on 10-year borrowing briefly reached 5.13%, close to levels last seen during the 2008 global financial crisis.
The move came as investors were already nervous about the inflationary impact of higher oil prices linked to the Iran war. The added possibility of political change in the UK and a shift toward looser public spending intensified pressure on gilts, the pound and bank shares.
Oil Shock Keeps Inflation Fears Alive
Global bond markets have been under pressure since the Iran war pushed oil prices above 100 dollars a barrel. Higher energy costs can feed through to transport, food, utilities and business expenses, raising inflation expectations and increasing the risk of further interest rate hikes.
While borrowing costs have risen across several major economies, the UK has faced more elevated rates than some peers of similar size. Investors are concerned that Britain’s fiscal position leaves less room for policy error if inflation remains sticky and debt servicing costs continue to climb.
Leadership Uncertainty Adds A Risk Premium
The market reaction was sharpened by questions over whether a successor to Starmer could take a less restrictive approach to public spending. The prime minister and Chancellor Rachel Reeves have repeatedly pledged to maintain strict borrowing rules, describing them as central to market confidence.
However, some Labour MPs on the left of the party have questioned whether the current budget rules are suitable for long-term renewal. Analysts said any sign of fiscal loosening could lead investors to demand higher returns for holding UK government debt.
Capital Economics Warns On Fiscal Discipline
Capital Economics said UK borrowing costs would likely rise and the pound would weaken if there were a leadership change at the top of the Labour party. The firm argued that investors would be alert to any evidence of weaker fiscal discipline.
The analysts suggested potential challengers such as Andy Burnham, Angela Rayner and Wes Streeting would probably raise public spending. That perception matters because markets are highly sensitive to the credibility of fiscal policy, especially when inflation and debt costs are already elevated.
Banks And Sterling Come Under Pressure
The FTSE 100 fell more than 1% in early trade before recovering most of its losses to close down just 0.04%. Bank shares including Lloyds, NatWest and Barclays declined amid concerns about a possible tax raid under a future administration.
The pound also fell 0.5% against the dollar to 1.35 dollars. Anna Macdonald of Hargreaves Lansdown said the bond market had been unsettled by concerns that a different prime minister could relax or extend fiscal rules, prompting investors to demand a higher risk premium.
Debt Costs Become A Larger Budget Constraint
Government bonds, or gilts, are loans issued to investors to cover the gap between tax revenue and public spending. When investors see greater risk, they demand higher yields, which increases the cost of borrowing for the state.
On Tuesday, yields rose across two, five, 10 and 30-year maturities, with the 30-year gilt yield reaching 5.81%, its highest level since 1998. The 10-year gilt is the benchmark for government borrowing, while two and five-year gilts influence fixed mortgage rates. With debt interest now accounting for about 1 pound in every 10 pounds of government spending, higher yields could further limit fiscal flexibility and keep markets focused on both inflation and political stability.
