The last time yields on 30-year UK government bonds were this high, Rachel Reeves was a first-year student at Oxford, getting to grips with economics.
The chancellor could be excused a moment of nostalgia for such innocent times after waking on Tuesday to a barrage of headlines about Keir Starmer taking back control of economic policy – and a fresh sell-off in the government bond, or gilt, markets.
Alongside rising yields, meaning the government must pay more to service its debts, sterling was also declining on the foreign exchange markets, losing 1% against the dollar by mid-morning. This combination – rising yields and a declining currency – is often viewed as a warning signal of fragile investor confidence.
The 10-year yields that the Office for Budget Responsibility (OBR) uses to forecast future borrowing costs were also on the rise, hitting the highest level since January, at 4.82%.
Despite dark predictions about a 1970s-style budget crisis, market watchers were quick to point out that rising yields, particularly for longer-term government bonds, are not a UK-specific phenomenon.
“There’s a lot of hysteria about UK borrowing costs, but if you look what happened to yields in the UK, it’s not much different to what’s happened in other markets,” said Neil Shearing, the group chief economist at consultancy Capital Economics.
An auction of 10-year gilts by the Treasury’s debt management office on Tuesday – the way the government borrows from markets – was oversubscribed by 10 times. While that showed plenty of appetite for UK government debt, the yield was the highest since 2008.
There are several reasons for the global drift upwards in longer-term yields, which include the acute budget crisis in France, stirrings of inflation in Japan, and above all, Donald Trump’s extraordinary attacks on the independence of the Federal Reserve.
Economists generally see the independence of the Fed as strengthening its inflation-fighting credibility. It is unclear what will be the outcome of the legal battle between the Trump White House and Fed board member Lisa Cook, whom the president last week announced he was firing. But the scene appears set for acontinuing struggle to bring the institution under political control.
In the short term, US interest rates appear to be on the way down, as Trump has long demanded, after the Fed chair, Jerome Powell, used a speech at the recent Jackson Hole meeting to signal a change of position, pointing to the weakening US labour market.
But in the longer term, investors appear to be starting to fret about the credibility of US economic management, given Trump’s assault on a string of key institutions, and his plans to borrow trillions more. One way those doubts have been expressed is in a sell-off of long-dated Treasury bonds. Gold has shot up to a fresh record high too, in another potential sign of investor anxiety.
But no matter the global nature of this latest bond market sell-off, it only adds to the intense pressures facing Reeves as she – and No 10’s new hires – prepare for the budget, now set to be in November at the earliest.
A downgrade of the OBR’s expectations for future productivity, and therefore economic growth, together with the U-turns on winter fuel payments and planned benefits cuts, are expected to leave Reeves with a hole of perhaps £20bn or even £30bn to fill, if she wants to continue meeting her fiscal rules.
News that No 10 plans to wade into pre-budget planning, after a flurry of speculative stories about tax rises, does not appear to have reassured investors.
Any package of possible tax rises will have to satisfy No 10’s determination to avoid a winter fuel-style voter backlash, without sparking consternation in fretful bond markets.
Few in the City or Westminster expect Reeves to rewrite her fiscal rules or tear up Labour’s pre-election pledges on taxing “working people”. She may well implement the International Monetary Fund’s recommendation of only having one binding OBR forecast a year, to avoid the six-monthly scramble to meet targets based on highly uncertain forecasts, five years ahead.
That will save her some pain in the spring, but meanwhile she is expected to be casting around for significant extra revenue from somewhere, with markets watching closely.
“It’s the classic ‘you wouldn’t start from here’,” says HSBC’s chief European economist, Simon Wells. “This is going to be a muddle-through, stick-to-the-rules kind of budget; that’s all she can really do.”
