UK borrowing costs climb as ‘stagflation’ fear stalks gilt market

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Concerns about Britain’s stagnant economy and accelerating inflation have unnerved investors, pushing borrowing costs to their biggest premium over German debt yields since 1990.

The spread between the two countries’ bonds rose above 2.3 percentage points, the highest since German reunification and eclipsing the peak reached two years ago after Liz Truss’ ill-fated “mini” budget.

“Stagflation concerns are back for the UK bond market,” said Robert Dishner, senior portfolio manager at Neuberger Berman.

He added that investors were also “a bit distracted” by the scale of the Labor government’s borrowing plans, which could increase further if weak growth holds back tax revenues.

The gilt market’s moves come ahead of the Bank of England’s year-end policy meeting on Thursday, with investors betting that firm inflation would prevent the central bank from lowering its benchmark interest rate despite a stagnant economy.

Recent data have shown GDP shrank unexpectedly in October for the second month in a row.

The climb in gilded The yield also pushed government borrowing costs back to their highest levels in nearly a year, reached last month after Chancellor Rachel Reeves’ October Budget briefly unnerved investors by ramping up the Treasury’s debt issuance plans.

The 10-year gilt yield rose 0.05 percentage point to 4.57 percent on Wednesday, following UK inflation figures. accelerated to 2.6 percent in November.

“Higher borrowing costs continue to undermine the UK’s fiscal position,” said Mark Dowding, chief investment officer at RBC Bluebay Asset Management.

“If the gilt concession rises above the level seen in Truss’ anger, Rachel Reeves may end up breaking more promises and having to raise taxes or cut spending to allay debt sustainability concerns.”

The last rise in yields was less than 4.2 percent two weeks ago, with traders betting the BoE will now make just two quarter-point cuts next year, down from four expected in October.

The data “calls into question the Bank of England’s ability to cut rates,” said Craig Inch, head of rates and cash at Royal London Asset Management.

The yield gap with the eurozone is also largely driven by investor expectations that the European Central Bank will cut borrowing costs much faster than the BoE as it grapples with a sharper slowdown in growth.

In addition, the rise in yields reflects a sell-off in the US Treasury market, where investors have scaled back their expectations of a Federal Reserve rate cut in 2025 following Donald Trump’s election victory last month.

Economists had long expected UK price pressures to rebound at the end of the year due to so-called base effects, as energy costs fell a year ago, the benchmark when calculating annual inflation.

However, BoE policymakers are also concerned about the scale of price increases in the services sector, as well as rapid wage growth.

Services price growth of 5 percent in November was higher than the Bank’s forecast of 4.9 percent and well above the central bank’s 2 percent inflation target.

Separate figures earlier this week showed that average weekly earnings in the UK, excluding bonuses, rose faster than expected by 5.2 per cent in the three months to October.

Higher government spending and borrowing in Reeves’ budget could also add to inflationary pressures.

The measures would add 0.75 percentage points to GDP and about 0.5 percentage points to consumer price inflation in about a year, according to BoE forecasts late last month.