gGovernment borrowing costs rose at the fastest rate in nearly three decades in August, creating a headache for the next prime minister.
Yields on short-term UK gilts, which influence government borrowing costs, jumped more than a percentage point last month to 2.8%, the biggest monthly rise since 1994.
Borrowing costs rise as investors grow increasingly worried about Britain’s bleak economic outlook and doubts grow over the ability of Boris Johnson’s successor to handle the growing cost of living crisis .
Goldman Sachs analysts warned this week that inflation could peak at over 22% in Britain if energy costs continue to soar.
Rishi Sunak, the former Chancellor, has warned it would be ‘complacent and irresponsible’ to ignore the risk of financial markets losing confidence in the UK economy
Mr Sunak, who is competing with favorite Liz Truss in the Tory leadership race, told the Financial Times that his rival had made unfunded spending commitments which he said could drive up inflation and interest rates and increase borrowing costs in the UK.
Philip Shaw, chief economist at Investec, told Reuters the nature of the fiscal support Ms Truss is expected to plan as prime minister was a concern for investors.
Ms Truss, the Foreign Secretary, recently hinted at direct support for households as well as tax cuts, which would add to Britain’s still huge borrowing levels after the pandemic.
Government borrowing costs are also rising in Europe as investors brace for more aggressive central bank rate hikes amid an inflation crisis.
The yield on the 10-year German Bund, seen as a barometer of borrowing costs in the eurozone, rose more than 0.7 percentage points in August – the biggest monthly rise since 1990.
Rohan Khanna, strategist at UBS, said UK government borrowing costs are likely to struggle more in the coming months.
He said: “The main risk we see here is that large-scale fiscal measures (rather than targeted and measured) will aggravate already elevated inflationary pressures and trigger an even stronger monetary policy response.
“We expect such a hostile fiscal and monetary mix to raise alarm bells for gilt market participants and trigger further underperformance across markets.”
Mr Khanna expects yields on UK 10-year gilts to rise to 3.25%.
While Goldman said the 22% inflation forecast was not its base case scenario, it warned that the risks to which the UK economy was “tilted to the downside” with a “more severe and prolonged recession “more likely than a quick recovery.
He expects an additional £30billion of government support for households and businesses will not be enough to prevent a ‘mild’ recession, with an increased risk that households will cling to savings in the instead of spending it.