Governments around the world are uncomfortably watching their borrowing costs rise, following the lead of the U.S. Treasury market. But even in a global rout in bonds, Britain stands out.
British government bonds, known as gilts, are suffering a particularly harsh sell-off, as investors recoil from the country’s low economic growth, stubborn inflation and high debt levels. The yield on 10-year gilts, the benchmark rate, reached 4.9 percent on Tuesday, the highest since 2008, while yields on 30-year bonds were the highest since 1998.
The surge in borrowing costs puts the British government’s plan to revive economic growth, by allocating more money for public services and greater investment, at risk less than three months after it was announced.
“At a time when yields are rising everywhere, global investors are looking at the U.K. like the weakest link in the chain,” said Hugh Gimber, a strategist at J.P. Morgan Asset Management.
And it’s not just bonds. The British pound is at its lowest level against the dollar in more than a year, performing worse than other major currencies in the past month, and stocks have fallen in London.
Gilts and other countries’ government bonds have been tracking yields on Treasury bonds higher. Since the U.S. presidential election, borrowing costs have risen as investors with an eye on fiscal discipline expect President-elect Donald J. Trump to enact policies that will lead to higher inflation, while successive strong labor market reports have also diminished expectations for interest rate cuts by the Federal Reserve.
Although the British government is not directly responsible for the surge in its borrowing costs, it will have to face the implications for its economic plans.
In late October, Rachel Reeves, the chancellor of the Exchequer, stood in Parliament to deliver the Labour Party’s first budget in 14 years. She announced a 70 billion pound ($85 billion) annual increase in public spending over the next five years, about half of which is paid for by higher taxes and the other half through borrowing. She also said she would stick to strict fiscal rules that would bring debt levels down.
The move was considered a gamble, a decision to spend a lot of public money in the short term, encourage investment and hope that leads to more economic growth that would improve the country’s debt load and avoid having to significantly raise taxes again.
But sooner than expected, this plan is being put to the test. The rise in bond yields has made repaying debt more expensive, wiping out the buffer for Ms. Reeves’s fiscal rules.
“We’ve got clear fiscal rules and we’re going to keep to those fiscal rules,” Keir Starmer, the prime minister, said on Monday.
If this persists until March, when the Office for Budget Responsibility, an independent watchdog, publishes its semiannual economic forecasts, Ms. Reeves will have to decide whether to raise taxes further or cut spending to stick to her rules.
“You have a government which is left with some difficult choices,” said Mr. Gimber of J.P. Morgan Asset Management, because it has ruled out raising taxes again and it would be hard to cut spending from government departments that are already stretched. “Therefore, global investors are left looking at the growth and inflation mix and demanding more compensation from U.K. gilts,” he said.
The desires of global investors are particularly relevant for Britain as about a third of its government bonds are owned by foreign investors.
The implications of turmoil in the bond markets are fresh in Britons’ minds. In late 2022, the government of then Prime Minister Liz Truss announced an aggressive plan to cut taxes and increase borrowing, sidelining the fiscal watchdog in the process. Bond yields soared, the pound plummeted, the central bank had to intervene to stabilize markets and within weeks, Ms. Truss was ousted. The fears of a repeat have lingered, encouraging the Labour Party to insist that it would govern with iron fiscal discipline.
“This is very different from the 2022 market scenario,” Mr. Gimber said. “That was a period where gilt yields were really leading global bond yields higher. This time round, gilt yields are being caught in a global bond yield move.”
Still, there are scarce signs of relief. Data published on Wednesday is expected to show inflation sticking at 2.6 percent, meaningfully above the Bank of England’s 2 percent target. Traders are betting that the central bank will cut interest rates only once this year.
This will keep up the pressure on the government to respond with fiscal plans that calm markets without abandoning its economic strategy.
Changing the budget would look “politically weak,” said Benjamin Caswell, an economist at the National Institute of Economic and Social Research. These policies are still new, he added, and many of them will not be enacted until April, so they need time to work through the economy.
“It depends whether they have the political capital and the will to ride it out,” he said.