Borrowing expenses increase at the quickest rate since the Truss mini-Budget

UK Government Borrowing Costs Surge Amid Iran Conflict

The cost of borrowing for the UK government is climbing at its fastest rate since the financial turmoil following Liz Truss’s mini-Budget, as market volatility intensifies due to the ongoing conflict in Iran.

This week, yields on 10-year UK government bonds, commonly referred to as gilts, have jumped from 4.23% to 4.69%—an increase of over 0.4 percentage points.

Such a rapid rise in gilt yields, which serve as a key indicator for the expense of managing Britain’s £2.9 trillion national debt, has not been seen in the past four years.

The last comparable surge occurred in the aftermath of Chancellor Kwasi Kwarteng’s announcement of £45 billion in unfunded tax reductions in September 2022, when 10-year gilt yields soared by 54 basis points within a single week.

According to Andrew Goodwin, an economist at Oxford Economics, if this upward trend in government borrowing costs persists, it could reduce the Chancellor’s fiscal flexibility by £1.5 billion.

Bond yields—which represent the returns paid to investors who purchase government debt—have been rising sharply worldwide, fueled by concerns that escalating oil and gas prices could reignite inflation.

Energy Prices Put Pressure on Markets

James Athey, a fund manager at Marlborough Group, noted that the spike in oil and gas prices has left energy-dependent economies such as the UK and Europe particularly vulnerable.

He explained, “With so much uncertainty about the duration of this disruption and how central banks might react, investors are hesitant to expect imminent rate cuts.”

Athey also pointed out that bond yields have been propelled higher as hedge funds unwind significant positions that had anticipated falling interest rates this year, resulting in notable movements in shorter-term yields. For example, yields on two-year UK gilts have increased by more than 40 basis points this week—the largest jump since August 2024.

“It’s not a logical repricing, and UK yields are now, in our view, excessively high. However, with so much unpredictability and the weekend approaching, it’s hard to resist the momentum,” Athey added.

Impact of the Iran Conflict on Financial Markets

The ongoing war in Iran has caused significant turbulence in financial markets, as investors attempt to assess the potential for prolonged disruptions to oil and gas supplies.

Market sentiment has shifted so dramatically that traders no longer expect the Bank of England to cut interest rates again this year, despite having anticipated at least two reductions just a week earlier.

Oxford Economics forecasts that household energy costs in the UK will climb by 13.5% from July, as the effects of higher oil and gas prices ripple through the economy.

Expert Insights and Market Reactions

Edward Allenby, a senior economist, predicts that disruptions to shipping through the Strait of Hormuz could last at least two months, potentially pushing UK inflation from an average of 2.3% to 2.7% this year, with oil prices expected to average just under $80 (£59.70) per barrel in the second quarter.

Neil Birrell of Premier Miton Investors cautioned that “even now, the heightened risks from the Middle East conflict are only beginning to be reflected in commodity and interest rate markets.”

He added, “The speed and magnitude of these changes are likely to soon affect equities and other asset classes.”

On Friday, Brent crude—the global oil benchmark—exceeded $90 for the first time in two years, setting the stage for its largest weekly gain since the initial Covid-19 lockdown in 2020.

Meanwhile, European natural gas prices have soared by 67% over the past week, marking their steepest increase since Russia’s invasion of Ukraine in 2022.

Robin Brooks, former chief economist at the Institute of International Finance, emphasized that the risks posed by the current conflict are “an order of magnitude greater” for oil markets than those seen during Russia’s invasion of Ukraine.

He expressed a particularly pessimistic outlook, noting that the Iranian government “is fighting for its survival.”