Fears of a long recession and the likelihood of higher government spending to deal with the cost of living crisis have pushed the interest rate on Britain’s debt to its biggest monthly rise in nearly 40 year.
Yields on ten-year UK government bonds, which are a proxy for the effective interest rate on government bonds, rose to 2.78% to register the biggest monthly rise since September 1986.
Pressing the new Prime Minister to deal with the deteriorating Treasury financial outlook, some analysts predicted that the yield would rise before the end of the year to at least 3%.
It comes as Rishi Sunak said there were growing risks financial markets would lose confidence in the UK economy amid soaring inflation and high levels of public debt, in an attack on fiscal plans and spending by her conservative rival Liz Truss.
About a third of the UK’s total borrowing has an interest rate linked to inflation, making it more expensive to finance in times of rising prices.
Truss, the favorite in the race to succeed Boris Johnson, has come under fire from opposition parties for proposing £50billion in tax cuts that will boost the incomes of rich and poor households and profitable businesses over the next year.
Sunak said he was “struggling to see” how the sweeping tax cuts to support families with the cost of living crisis “add up”. Using an interview in the Financial Times, he warned it would be “complacent and irresponsible” to ignore the risk of losing financial markets’ confidence in Britain.
“We have more inflation-linked debt than any other G7 economy – roughly more than double,” he said.
UBS analysts said the number of investors willing to lend to the UK government was likely to start to dry up, helping to push the yield on the 10-year gilt above 3%.
The pressure on the government’s borrowing position comes as European and US bond yields also rose, with the US 10-year Treasury note already at 3.11%.
However, while this increase in Washington’s borrowing costs has not shaken confidence in the longer-term prospects of the world’s largest economy, keeping the value of the dollar at record lows, the pound has fallen sharply. at levels seen after the Brexit vote six years later. from.
The pound has fallen 5% against the dollar to $1.20 and 3% against the euro this month in response to clear signs that Britain’s economy will suffer more than rival industrialized nations face rising gas and electricity prices and weakening private sector activity.
The prospect of higher borrowing costs when Bank of England policymakers meet to set interest rates in September, even as the economy enters a prolonged recession, also contributed to the the pound is having its worst month since the end of 2016 against the dollar and its worst against the dollar. euros since mid-2021.
Speeches by central bankers at the annual conference in Jackson Hole in the United States last week fueled concerns among financial market investors that interest rates would need to rise further to ease inflationary pressures, despite forecasts of a recession in most developed economies.
Azad Zangana, senior European economist at investment manager Schroders, said: “A definitive regime shift has occurred, taking us into a new era. More experienced investors might see this as a throwback to more normal times, akin to the run-up to the 2008 global financial crisis.
“However, that remains to be seen. Perhaps the stagflation—a period of consistently high inflation combined with high unemployment and stagnant demand—experienced in the late 1970s and early 1980s is the more apt comparison.
Financial markets are pricing in a 40% chance that the Bank will raise interest rates by 0.75 percentage point to 2.5% next month, which would be its biggest increase in borrowing costs since 1989. Investors expect rates to hit 4.25% by the middle of next year.
UK consumer price inflation hit 10.1% for the first time in 40 years in July, and the Bank expects the CPI to top 13% in October, when regulated household energy prices should increase by 80%.
Goldman Sachs predicted on Monday that UK inflation could hit 22% early next year, if natural gas prices stay near current levels. The Bank and many other forecasters expect rising inflation to push the UK economy into a long recession later this year.
An Office for National Statistics assessment of the impact on inflation of rebates on government energy bills for households found that they could not be considered an inflation cut.
Bloomberg analysts had estimated that a lower inflation verdict would have saved the UK government up to £14 billion in the cost of funding index-linked government bonds.