UK long-term borrowing prices hit highest stage since 1998 | USAEMALL.com

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The UK’s long-term borrowing costs have hit their highest level since 1998, as a bond sell-off threatens to wipe out the “headroom” chancellor Rachel Reeves has under her recently overhauled fiscal rules.

The yield on the 30-year gilt touched 5.22 per cent on Tuesday, pushing past a previous peak in October 2023 and eclipsing levels reached during the height of the market fallout from Liz Truss’s ill-fated “mini” Budget the previous year.

The new high came after the Treasury paid its steepest 30-year borrowing cost this century, as it sold £2.25bn of new debt at a yield of 5.20 per cent.

Recent gains in interest costs would, if sustained, nearly erase the room for extra borrowing allowed by the chancellor’s own budget rules, economists warned on Tuesday. The moves come alongside weakening growth expectations that could further worsen the outlook as ministers await a new set of fiscal forecasts in March.

The strains in the UK market come amid a global sell-off in government bonds in recent months, driven in part by fears that US president-elect Donald Trump’s tariff plans will be inflationary.

Gilt investors have been particularly worried that a mix of anaemic growth and persistent price pressures will push the UK into a period of stagflation, where the Bank of England is constrained from cutting rates to support the economy.

“You’ve probably got a bit of a buyer’s strike going on at the moment,” said Craig Inches, head of rates and cash at Royal London Asset Management. He said a combination of a high volume of long-dated gilt sales and “mixed” UK economic data was deterring investors from ultra-long-term debt.

The UK economy contracted for a second straight month in October, and failed to grow in the third quarter. Business confidence has taken a knock in the wake of Reeves’ decision to levy a £25bn increase in employer national insurance contributions in the Budget which, coupled with planned increases in the national living wage, will drive up labour costs. 

At the same time, recent data shows continued signs of sticky inflation. Consumer price growth accelerated in November to 2.6 per cent from 2.3 per cent the previous month, prompting investors to pare back hopes for interest rate cuts in 2025.

The gilt movements will be of acute concern in the Treasury, given Reeves left herself only £9.9bn of headroom against her key fiscal rule when she set out borrowing plans in the October Budget. 

The Treasury is expecting a fresh round of official forecasts from the Office for Budget Responsibility in March, which will include a new estimate of the amount of wiggle-room the government has against its self-imposed fiscal regime. 

Ruth Gregory, economist at Capital Economics, said the latest gains in yields and rate expectations would, if sustained, leave the chancellor with just £1.1bn of headroom against the chancellor’s key budget rule, which requires her to cover current spending — excluding investment — with tax receipts. 

That is before any adjustments in the OBR’s economic forecasts, which will also affect the fiscal outlook.

The final headroom forecast will not be determined until closer to the release of the next OBR outlook. The fiscal watchdog has to produce two forecasts every financial year, and it is due to provide an update on March 26 on whether Reeves is on track to meet her borrowing rules.

But a set of forecasts suggesting the Treasury is violating its fiscal rules would present a massive headache coming so soon after the chancellor’s first Budget.

The situation is particularly difficult given the chancellor’s decision to hold only one major fiscal event a year, meaning she intends to wait until this autumn before pushing through her next set of tax and borrowing decisions. This means any forecast breach of the fiscal rules before then might need to be remedied via tough spending measures.

“If the OBR judges in March that the main fiscal rule is broken, to maintain fiscal credibility, the chancellor may need to take some form of action,” said Gregory.

“So there is a risk that to meet the main fiscal rule, extra revenue-raising tax hikes or spending restraint will be required. Either way, there appears to be a risk that fiscal policy is tighter than otherwise.”