Government borrowing costs soar as Iran war drags on
The government’s borrowing costs have risen to their joint highest level since the 2008 financial crisis, after a sharp jump in the oil price prompted a sell-off in UK debt because of concerns over inflation.
The yield on the 10-year gilt – the main benchmark for any government’s long-term ability to borrow – climbed back above five per cent for only the third time since the Iran war broke out on Tuesday, laying bare the extent to which Britain is almost uniquely exposed to the ongoing energy shock.
The UK’s government borrowing costs have risen the most of any developed economy in the past two months, with moves particularly pronounced at the shorter end of the yield curve, which closely tracks the interest rate path.
The yield on the two-year gilt has risen by more than a full percentage point since the start of March, as traders were forced aggressively to pare back earlier bets on the number Bank of England rate cuts they forecast this year.
But as the war has dragged on, the sell-off has spread to the government’s longer-dated coupons, as fears the country will struggle to insulate itself from future crosscurrents will compound bond markets’ reservations over the country’s growth prospects and grasp on the public finances.
Analysts have warned that a succession of policy errors and the UK’s reliance on oil and gas imports mean the British economy is particularly vulnerable to external shocks because of the knock-on effect that higher energy imports will have on already elevated prices.
And the path has exaggerated the pre-existing difference – known as the spread – between the UK’s borrowing costs and those charged to the US. The spread between the 10-year gilt yield and the US Treasury’s interest rate has now reached 70 basis points for only the second time since late 2025.
‘Policy mistakes’ blamed for sky-high borrowing costs
“Over the past decade, the UK economy has suffered a succession of policy mistakes and resulting rates of inflation which have consistently exceeded the prevailing trends across other major economies,” Kallum Pickering, chief economist at Peel Hunt, wrote in a note. “Unsurprisingly, it no longer takes much to spook UK government debt markets.”
The Bank of England has struggled to bring price rises to heel as successfully as rival central banks ever since since Russia’s full-scale invasion of Ukraine and Liz Truss’s fateful mini-Budget combined to push inflation into double digits in 2022. Stubborn inflation is a major bugbear of bond investors, as price rises eat into the real returns one generates from bond over the course of its maturity.
Before the war, price rises had been forecast to mollify, after three years of stubbornly sticking above the Bank’s two per cent target. And a succession of positive government borrowing figures – boosted by record tax receipts – had helped alleviate traders’ concerns over the government’s grasp on the public finances.
But those positive developments, which had helped bring down borrowing costs over the first three months of the year, were knocked off course by the Iran war and its effect on the oil price. On Tuesday, Brent crude was trading at over $111, its highest price since the war began on 28 February, after ceasefire talks between the US and Iran broke down.
Kathleen Brooks, research director at XTB, said: “Yields are likely to creep higher as we lead up to the key central bank meetings this week, and as we wait to hear what happens next in the Strait of Hormuz.”