Key Points
- Global bond yields are rising on fiscal concerns, but U.K. borrowing costs face further specific challenges.
- Those include its joint current account and fiscal deficit, persistent inflationary challenges and modest growth expectations.
- A particular challenge on the long-end is a change in composition of gilt holders toward foreign hedge funds, which demand a higher premium for risk.
The U.K.’s long-term borrowing costs hit their highest level in nearly three decades on Tuesday, reflecting both a global move higher in bond yields and a specific cocktail of concerns afflicting the gilt market. The yield on 30-year U.K. government bonds , known as gilts, was up 7 basis points on the day at 1:56 p.m. in London (8:57 a.m. ET) at 5.709%, its highest level since 1998. Shorter-dated yields also ticked higher, with 2-year and 10-year yields up by 4 and 7 basis points respectively. That coincided with a fall in the British pound , which dropped by 1.5% against the U.S. dollar, as investors assessed the Labour government’s reshuffle of several senior advisory roles . The moves have been interpreted as preparation for the highly-anticipated budget coming later this fall, and an attempt to drive a reset amid political pressures and tepid economic growth . Gilts tend to be highly sensitive to news events and risk tolerance due to the composition of their holders — particularly foreign hedge funds — as evidenced during the global bond sell-off in April this year, when the 30-year yield spiked up to 30 basis points. While Tuesday’s moves were less dramatic, the creep back to a fresh 1998 high for the 30-year — a milestone also reached earlier in the year — reignited discussion about the additional pressure on Finance Minister Rachel Reeves over debt sustainability. Reeves has staked much of her credibility on meeting a set of self-imposed “fiscal rules” aimed at reducing U.K. debt as a proportion of GDP, and covering day-to-day spending with revenues, meaning further tax rises are widely expected . Steadily rising borrowing costs further complicate that picture. The U.K. is in a poor financial position with both a current account and fiscal deficit, Jason Borbora-Sheen, multi asset portfolio manager at Ninety One, told CNBC by email. “A staunch position from [Reeves] and tougher political decisions (that involve higher taxation and less spending) would tame the move in the long-end, likely at the expense of some short-run growth, but ultimately demonstrate a more resilient long-term approach,” Borbora-Sheen said. Global picture The U.K. is not alone in facing rising long-term yields related to investors’ fiscal concerns. U.S. Treasury yields jumped on Tuesday on questions over the future of tariff revenues. The 30-year yields of Germany, France and the Netherlands were meanwhile at highs last seen during the 2011 euro crisis, Deutsche Bank’s Jim Reid noted Tuesday, describing the trend as a “slow-moving vicious circle: rising debt concerns push yields higher, worsening debt dynamics, which in turn push yields higher again.” But the U.K. 30-year is high on a relative basis to other big economies such as France and the U.S., even as the former faces the potential collapse of its government over a budget dispute and the latter sees pressure from President Donald Trump on the independence of the Federal Reserve . Much of the world has been plagued by high inflation and growth concerns over the past few years, but the U.K.’s inflationary pressures have resurged in recent months ahead of those in the euro zone and U.S. That has led to reduced expectations for further Bank of England rate cuts this year , impacting short-term yields. Pressure on the U.K. long-end is further exacerbated by “acute” factors, Ken Egan, director of European sovereign credit at Kroll Bond Rating Agency, told CNBC. “Fiscal positions were already stretched before this year’s additional defense commitments , and now the market faces a heavier bond supply alongside a shifting investor base,” Egan told CNBC. A retreat by domestic pension funds and insurers, once the dominant “long-term anchors” of long-dated gilts, has been replaced by hedge funds and overseas buyers who demand a greater premium for fiscal concerns and to absorb greater supply, he said. “Overweight overseas participation can appear positive when demand is strong, but it risks disorderly selling if the narrative turns against gilts,” he added, flagging a potential scenario in which a few months of negative news flow adds “billions to the government’s borrowing bill, enough to wipe out the revenue from whole tax streams.” Egan added that gilt auctions themselves nonetheless remain robust, with “consistently strong cover ratios and deep demand across maturities,” and that the Debt Management Office’s shift this year in issuance toward shorter maturities should ensure the continued smooth functioning of the market. — CNBC’s Holly Ellyatt contributed to this story.
