Interest rates on UK long-term government loans reach a 27-year peak amidst turbulence in the international bond market
In the lead-up to the 26 November budget, Chancellor Rachel Reeves is grappling with a significant fiscal challenge - filling an estimated £40bn hole. This comes as the UK economy is projected to grow by 3.5-4% annually in cash terms over the next few years, but the average interest rate on government debt remains at about 3.9%.
Yesterday, the UK sold £14bn of gilts, meeting a record demand of £150bn. This was the largest issuance day on record in Europe. The yield on 30-year gilts climbed to 5.747% in early trading, surpassing the 5.723% peak hit on Monday, marking the highest level since 1998.
The pressure in the gilt market is concentrated at the long end of the curve, with yields on 10-year gilts also rising to their highest level since January. Across Europe and the US, issuance also hit records. Yields on US 30-year bonds breached 5%, and French, German, and Japanese yields are also climbing.
Fred Repton of Neuberger Berman pointed to a surge in debt issuance as markets reopened after the US Labour Day holiday as a contributing factor to the rise in gilt yields. The rise in gilt yields reflects growing investor concern about the sustainability of the UK's public finances.
The UK government's debt stands at about 96% of GDP, rising sharply from 575 billion pounds in 2007 to 2.9 trillion pounds. This increase is driven by financial crises and the pandemic, with growth and managing debt costs currently key challenges. The UK also faces the highest inflation and government borrowing costs among G7 nations, restricting fiscal policy flexibility.
Thomas Pugh, chief economist at consultancy RSM UK, warned that the UK risks sliding towards a "debt trap", where the interest rate on government debt exceeds the economy's nominal growth rate. However, despite the high gilt yields, predictions of a 1970s-style crash and IMF bailout were dismissed by analysts.
With less than three months until budget day, gilt markets are sending a clear signal to Westminster - the room for maneuver is narrowing fast. The UK still has the second-lowest debt-to-GDP ratio in the G7, offering some reassurance.
The UK gilt syndication and today's linker sale represent the largest sovereign issuance ever for the UK. Analysts attributed the rise in gilt yields to a broader shift across global markets. Only when the 10-year yield significantly increases should there be serious concern.
In conclusion, the UK's budget is facing significant challenges due to rising gilt yields and a large fiscal hole to fill. The economy's growth and the UK's public finances are under scrutiny, and the government will need to navigate these challenges carefully to ensure a stable economic future.
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