The recent surge in the government’s borrowing costs is the highest recorded since 1998, driven by the aftermath of the Iran conflict and uncertainties surrounding the future of PM Keir Starmer. On Tuesday, the interest rate on 30-year government bonds peaked at 5.77%, surpassing last September’s 27-year high. This increase poses a risk of further elevating the government’s borrowing expenses, particularly as the economy grapples with the repercussions of the Middle East turmoil.
Simultaneously, the UK’s FTSE 100 index experienced a decline, dropping nearly 130 points to 10,232.71 by 1 pm, marking a 1.27% decrease. The yield on 10-year gilts, which mirrors new public debt costs more accurately, also rose above the 5% threshold to 5.095%, indicating a potential closure at its highest level since 2008.
This trend is not exclusive to the UK, as both US and German bond yields have also been on the rise due to ongoing disruptions in the Strait of Hormuz. The prevailing uncertainty surrounding the upcoming local elections this Thursday and its potential implications for the Labour party have triggered investor concerns. There is a growing apprehension among investors about a likely challenge to Sir Keir’s leadership if the Labour party underperforms in the elections.
Thomas Pugh, the chief economist at RSM UK, cautioned that a leadership change could further escalate government borrowing costs. He emphasized that the recent focus on the Iran conflict has temporarily shifted attention away from domestic politics. However, with the upcoming elections likely to impact government stability, businesses and households face heightened uncertainty that may deter investment and spending.
Moreover, the possibility of a leadership challenge could prompt financial markets to react by pushing gilt yields higher. This scenario could result in increased borrowing costs across the economy, given the potential for a successor to adopt a more financially liberal approach compared to Starmer and Reeves. The risk of a disorderly leadership transition, coupled with speculation about tax hikes and subsequent budget adjustments, could exacerbate the economic slowdown caused by rising energy prices, potentially pushing the economy further towards stagnation.
As the national debt currently stands at around £2.9 trillion, nearly equivalent to the UK’s annual gross domestic product, the rise in gilt yields will escalate the expenses associated with servicing the public sector’s borrowing. The Office for Budget Responsibility estimated these costs at £111 billion in the previous financial year.