The Debt Management Office has been forced to sell nearly £5bn of five-year gilts at their highest interest rate since 2008, underscoring the fiscal challenge facing John Healey on the eve of his maiden Budget.
The body responsible for selling the UK’s debt said it had issued £4.5bn of bonds maturing in 2032 at a yield of 5.04 per cent on Tuesday. The figure is the highest annual payment since the global financial crisis sent stock markets plunging and interest rates to historic lows.
The auction was 3.5 times oversubscribed, the Debt Management Office (DMO) said, as investors looked to hoover up UK government bonds at a time where they are attracting the highest yields of any G7 economy.
Government bond yields have climbed sharply since the onset of the Iran war amid escalating concerns over the conflict’s inflationary impact and developed economies running persistently large deficits.
The yield on the 10-year Treasury – the world’s most widely traded bond – has climbed by more than a full percentage point since the war began, while the yield on France’s 10-year OATs have risen by 1.73 percentage points.
Bond yields leave no space for ‘spending or tax relief’ at Budget
But despite outperforming rivals in recent months, bond yields in the UK remain the highest of all developed economies despite a deficit reduction plan that was recently lauded by the International Monetary Fund. Investors have pointed to Britain’s exposure to inflationary shocks and years of political uncertainty as the reasons for the high premium they charge to hold its bonds, known as gilts.
“Higher bond yields help attract the foreign capital the UK needs, but they also raise the government’s interest bill, eroding fiscal headroom and leaving even less space for spending or tax relief,” said Kevin Thozet, portfolio adviser at Carmignac. “The more expensive it becomes to fund the external deficit, the more difficult it becomes to run an expansionary fiscal policy.”
The five-year gilt auction lays bare John Healey’s challenging economic landscape as he prepares to deliver his first Budget as Chancellor on Wednesday. The UK now spends more than £115bn a year servicing its debts, which is more than its education budget for England and roughly double the country’s defence budget.
Healey has committed to his predecessor Rachel Reeves’ self-imposed fiscal rules as well as her pre-election promise not to raise any of the three largest taxes. As part of that self-imposed spending straitjacket, Healey must bring the government’s day-to-day spending to heel, matching it with tax receipts by the end of the parliament in 2029.
Andrew Wishart, senior UK economist at Berenberg, said the Chancellor should stick to its strict fiscal consolidation, which “sets it apart from other major economies.”
“Deviating from the plan would cause investors to demand a larger term premium for holding gilts,” he added.