Thirty-year UK government bond yields surged to 5.89% on Tuesday, marking their highest point since 1998. The 10-year benchmark also saw its yield climb to its highest since the 2008 financial crisis, nearing or exceeding 5.2%. This global bond selloff, fueled by Middle East oil shocks and inflation fears, is placing significant pressure on Chancellor John Healey's first budget, scheduled for October 28.
Analysts are projecting a substantial reduction in the Chancellor's fiscal headroom. Deutsche Bank estimates that if current yields persist, Healey's headroom against the government's budget rule could shrink from £26 billion to £13.8 billion, even before factoring in new spending. Bloomberg Economics similarly calculated a reduction of about £12 billion from the initial £23.6 billion cushion. This deterioration is primarily attributed to higher interest costs, as the Office for Budget Responsibility's March forecast assumed gilt yields of 5.1% for the year, well below current levels.
The volatile bond market comes amidst an already shaky fiscal backdrop. Public sector net borrowing hit £1.8 billion in July, a 69% increase year-on-year, and cumulative borrowing from April through July reached £56.7 billion, exceeding OBR forecasts by £2.3 billion. Furthermore, shop prices rose by 1.5% year-on-year in August, the fastest pace in over two years, indicating inflationary pressures. Liz Truss, the former UK Prime Minister, has warned that these surging gilt yields could force the current Labour government into emergency spending cuts, drawing parallels to the 2022 mini-budget crisis.
Market experts like Sanjay Raja of Deutsche Bank anticipate Healey will aim to protect at least £10 billion in headroom to reassure markets, though £15 billion would be ideal. The upcoming budget is seen as a critical test for the government's fiscal management. Institutional investors, such as Rathbones, are already reducing exposure to long-dated gilts due to a perceived lower threshold for market reactions compared to the 2022 crisis. The Bank of England is also anticipated to raise rates from 3.75% to 4.5% within the next 12 months, impacting housing finance with five-year mortgage swaps reaching 4.52%.
