Even in the global energy crisis, Britain’s economic struggles stand out. Government borrowing costs rose to their highest level in three decades, faster than other European and American bond markets.
With the British public going to the polls on Thursday, the rise in bond yields is a bad sign for the government, which is facing a negative outcome in the vote. Bond investors are concerned about the country’s political and economic instability as debt levels are high and inflation is low.
This week, the yield on 30-year government bonds, known as gilts, rose above 5.7 percent, the highest since 1998. The benchmark 10-year bond yield was close to 5 percent and is up about 5 percent this year. By comparison, the 10-year US Treasury yield rose less than 0.2 percentage points. The movement is three times larger than that in the German territories.
“It’s a perfect storm for the UK,” said Katharine Neiss, chief European economist at PGIM Fixed Income.
He cited three mutually reinforcing factors: Britain’s financial and economic systems, its vulnerability to external energy shocks due to its reliance on imported oil and gas, and its ongoing political uncertainty.
Some of these economic crises are shared by governments around the world. The successful closure of the Strait of Hormuz has sent electricity prices soaring. That feeds into rising costs and, for many governments, pressure to spend more to protect households and businesses, which may have to borrow more to do so.
Britain, however, starts from a painful place.
At the beginning of the war in the Middle East, inflation was 3 percent, which is a full amount above the central bank’s target of 2 percent. Interest rates were therefore relatively high to reduce inflationary pressure. The government, led by Prime Minister Keir Starmer, was widely unpopular. It tried to strengthen welfare spending, and raise taxes to support investment and public services, while trying to reduce debt levels. It was a complicated calculation that left Mr. Starmer, and members of his Labor Party, are not satisfied.
That said, there have been signs that the economic situation is improving. Inflation was forecast to fall sharply in April, and the central bank, the Bank of England, said it expected to keep cutting interest rates. Lower rates would have made it easier for the Treasury to spend more on interest payments. Another good indicator: The government borrowed less money than it expected last fiscal year, in March. the latest data shown.
But the war crushed these green shoots. Inflation eased to 3.3 percent in March and is now expected to accelerate this year. Investors quickly abandoned their expectations that the central bank would cut rates, instead betting on several rate increases throughout the year. Mortgage rates and other borrowing costs have increased. The International Monetary Fund has cut its forecast for Britain’s economic growth to 0.8% this year, from a previous estimate of 1.3%.
Now there is a risk of “bad wind,” said Ms. Neiss, “when inflation is high, interest rates should be high, which means financial pressures are strong.” That leads to difficult political decisions about tax and spending, “which makes the existing leadership vulnerable,” he added.
Some economists, including Ms. Neiss, they believe investors are overestimating their bets on multiple interest rate hikes this year. They argue that the labor market has cooled and workers are less likely to demand a raise and that companies have aggressively raised prices, reducing the likelihood of damaging inflation. Additionally, energy shocks may weigh heavily on demand, which in turn may reduce price pressures. Andrew Bailey, the governor of the Bank of England, also said last week that these economic conditions would make workers and companies cautious.
So far, investors have not rejected British goods. The pound has gained against the US dollar and the euro this year. The sale of 15 billion pounds of 10-year bonds met record investor demand last month. But investors want a higher return on this loan. The yield on sales was 4.92 percent, the highest since 2008.
For the government, higher borrowing costs are keeping pressure on investors as they watch local election results. Expectations are high – in the betting markets and elsewhere – that Mr Starmer will not see out a year as prime minister. If he is replaced by a candidate from the left of Labour, investors worry that the government could loosen the reins and increase Britain’s debt.
That could undermine the potential for future interest rate cuts or a recovery in economic growth, Andrew Wishart, an economist at Berenberg, said in a research note. “However, bond markets and election considerations will punish any prime minister.”
