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The UK’s borrowing costs have hit their highest level since the 2008 financial crisis, as disappointing public finance figures added momentum to a gilt sell-off sparked by fears of higher inflation.
Ten-year gilt yields — a benchmark for long-term government borrowing — rose 0.09 percentage points to 4.94 per cent on Friday, as worries swirled over the public finances and the prospect of rising inflation.
Surging oil and gas prices due to the conflict in the Middle East have driven up near-term inflation expectations and shifted market expectations from interest rate cuts to rises by the Bank of England, which has knocked bond prices.
Rising inflation concerns were compounded by the Bank of England, which on Thursday held interest rates steady but warned over inflation risks and opened up the door to a rise in interest rates.
“Unfortunately when gilts move, they move big,” said Pooja Kumra, rates strategist at TD Securities. “The extremely hawkish twist from the BoE was certainly not anticipated by market participants, where there had still been hope for delayed cuts.”
Two-year gilt yields — which track expectations for BoE interest rates — rose another 0.11 percentage points on Friday to 4.52 per cent, taking them to their highest level in more than a year, as oil prices rose more than 1 per cent to $110 a barrel.
Traders are now pricing in three quarter-point interest rate increases this year, a sharp contrast to the situation before the Iran war, when they were expecting two reductions in 2026.
The rise in borrowing costs will deepen the challenges facing chancellor Rachel Reeves. Concerns over the hit from an energy shock were exacerbated on Friday by figures showing the UK had borrowed a higher than predicted £14.3bn in February.
“February’s public finances figures showed that the fiscal position was worse than expected even before the full impact of the surge in energy prices is felt,” said analysts at Capital Economics.
The BoE was previously expecting UK inflation to subside to 2.1 per cent in the second quarter, but it now predicts CPI growth of 3 per cent. Inflation could accelerate to 3.5 per cent in the third quarter, well above its 2 per cent target, the BoE added.
Reeves doubled the headroom against her key fiscal rule to £22bn in the November Budget, but some economists warn this could quickly be whittled away by higher interest costs and lower growth rates when the Office for Budget Responsibility next delivers its economic forecasts.
Higher energy costs are also triggering speculation that Reeves will be forced to announce energy support packages to ease the pain for households, leading to a further rise in public borrowing.
Market experts Cornwall Insight said on Friday its latest estimate for the UK energy price cap for July to September would put typical annual household gas and electricity bills at £1,972, up from £1,641 between April and June.
