Rising borrowing costs are squeezing the UK government’s budget, impacting critical sectors such as the National Health Service, military, emergency services, and education.
The Labour government of Britain, already grappling with public dissatisfaction due to increased taxes, controversial spending choices, and political controversies just months into their term, now faces a significant challenge from escalating borrowing costs that could hinder their progressive agenda.
Since September 16, the yield on the UK’s 10-year bonds has surged over 1.1 percentage points, fueled by concerns over sluggish economic growth and persistent inflation. This spike has brought borrowing costs to their highest levels since the financial crisis of 2008.
The increasing costs mean that the government has less financial flexibility to address the urgent needs of the NHS and other vital services. Although officials experienced a slight reprieve with a dip in inflation rates in December, if the situation doesn’t improve soon, Prime Minister Keir Starmer may have to reassess his commitments to increasing funding and keeping tax rates steady for “working people,” promises that contributed to the Labour Party’s overwhelming victory in July.
Factors contributing to this turmoil include the return of U.S. President-elect Donald Trump, whose tax increase plans on imports have unsettled global markets and driven up bond yields worldwide. This predicament has also been exacerbated by the Labour government’s economic strategy predicated on optimistic projections of growth ramping up tax revenues.
What has triggered the recent financial turmoil?
Global bond investors are spooked by fears that Trump’s tariffs on imports could inflate U.S. consumer prices, prompting the Federal Reserve to maintain higher interest rates for longer periods, according to Susannah Streeter, Hargreaves Lansdown’s head of money and markets. Higher inflation typically leads to increased borrowing costs as bondholders seek to guard against investment devaluation.
A mere few months prior, investors anticipated multiple rate cuts from the Fed this year, but now the expectation has shifted to just one.
“The rise in gilt yields since early autumn has been primarily driven by global market conditions rather than any recent policy moves from the UK government,” stated the Institute for Fiscal Studies, a think tank focused on UK fiscal matters. “This assertion reflects market sentiment regarding anticipated higher interest rates from central banks in the near future.”
Gilts, which are UK government-issued bonds traded on the London Stock Exchange, are now a focal point of concern.
Is Britain facing this issue alone?
Certainly not. Many countries, including the U.S., are witnessing rising borrowing costs as well. However, Britain’s precarious economic landscape and high government debt levels make it particularly vulnerable.
Consumer price inflation in the UK fell to 2.5% for the year ending December, down from 2.6% the previous month, but it still remains significantly above the Bank of England’s 2% target. The British economy has seen stagnation recently, with GDP flatlining for the three months ending in September after growth of 0.7% and 0.4% in the earlier quarters.
This stagnation is partly attributed to the government’s decision to increase National Insurance taxes for employers and heighten workplace regulations, leading some businesses to pause investment and hiring.
“The UK is currently at the center of the storm,” noted Streeter, with “fears of stagflation increasing.” She elaborated, “As concerns over economic stagnation grow, inflation continues to exceed the Bank of England’s target, unsettling investors regarding UK government debt.”
What is the current state of Britain’s debt?
As of November, Britain’s government debt exceeded 98% of economic output, marking the highest level since 1963—a time when the country was still repaying World War II debts. Chancellor Rachel Reeves had expected economic growth to help reduce this debt-to-GDP ratio, introducing new fiscal guidelines that prohibit borrowing for day-to-day expenses by 2030 while vowing not to increase taxes on “working people.”
The rising borrowing costs complicate the government’s ability to achieve these objectives. However, it would be a significant challenge for Reeves to abandon her promises. Paul Johnson, director of the Institute for Fiscal Studies, commented, “She has clearly established her position, and it’s evident that market participants are increasingly worried about the UK’s fiscal trajectory.” He added that the UK relies heavily on international financial flows to manage its debt and trade deficits.
What measures are being taken?
Given these challenges, the new Labour government has had to take calculated risks, including seeking to enhance trade relations with China despite criticisms regarding national security. Reeves recently embarked on a three-day visit to China, aiming to attract investment rather than merely calming domestic market fears. Critics may scoff at this approach, but Reeves argues that engaging with China presents an economic opportunity that the UK cannot afford to overlook.
“Choosing not to engage with China is, therefore, not a viable option,” she opined in a recent article for The Times.
What comes next for Britain?
If high borrowing costs persist, Reeves may soon find her options limited, constraining her fiscal capabilities. A crucial policy update is anticipated on March 26, when Reeves is expected to present Parliament with the latest financial assessment, alongside updated economic and fiscal forecasts from the Office for Budget Responsibility.
Despite current market volatility, Streeter advises against panic. “Financial markets can experience fluctuations, but history shows that over the long haul, things tend to stabilize.”
Photo credit & article inspired by: Euronews
