(Bloomberg) — The UK’s long-term borrowing costs surged to the highest level in more than a quarter of a century, raising the prospect of Chancellor of the Exchequer Rachel Reeves needing to raise taxes again in order to meet her fiscal rules.
The yield on 30-year gilts climbed four basis points to 5.22% on Tuesday after the first of a string of bond sales due over the coming weeks. The yield was last higher in 1998 when Tony Blair was prime minister and the Bank of England was slashing interest rates from a six-year peak to contain the global fallout from the Asian currency crisis and Russian debt default.
Today’s Labour government is ramping up borrowing in an effort to improve Britain’s public services and boost investment in large infrastructure projects. Reeves has also committed to maintain fiscal discipline but was given just £9.9 billion ($12.4 billion) of headroom despite lifting taxes by more than £40 billion in her Oct. 30 budget.
“If market pricing sticks then the fiscal rules are probably going to be breached in the UK and they’re going to have to come back and do more,” said Jamie Rush, Bloomberg’s chief European economist. Reeves has insisted she will not raise taxes again, but some of her Cabinet colleagues, including Prime Minister Keir Starmer, have been less equivocal.
Even a modest increase in interest rate expectations and 20-year gilt yields could wipe out the Chancellor’s headroom altogether, according to Capital Economics, while Andrew Goodwin from Oxford Economics said rising borrowing costs put pressure on Labour’s upcoming spending review of government departmental budgets.
“We think tax rises are likely to be needed,” Goodwin added.
The UK’s Debt Management Office sold £2.25 billion on 30-year notes on Tuesday, paying a yield of 5.198%. The auction gave mixed signals of demand. While its oversubscription rate was the weakest since December 2023, at a bid-to-cover ratio of 2.75, the difference between the average and lowest yield accepted — known as tail — was just 0.3 basis points, indicating solid appetite for the notes.
The DMO will also sell £4.25 billion of new five-year bonds on Wednesday. That adds to a Monday BOE operation to reduce its balance sheet via the sale of securities in the seven- to 20-year bucket — a process known as quantitative tightening.
The Labour government’s plans to sell £297 billion of bonds this fiscal year — the second-highest on record — is keeping gilts under pressure, as investors worry about the outlook for the nation’s ballooning debt. Reeves’ budget preceded a bond selloff which has also lifted 10-year yields to the highest since October 2023.