Blow for Reeves as government borrowing costs highest since 2008

There was a fresh blow for Rachel Reeves as government borrowing costs hit the highest level since the financial crash of 2008.

The yield on 10-year bonds – the most widely used benchmark of government debt costs went over 5 per cent on City trading screens.

Sometimes such moves are a blip followed by a fall, but instead they stayed at 5.1 per cent on Tuesday.

The interest rate paid on UK government debt is a sign of confidence in the wider economy; the higher the yield, the more investors are demanding to lend to the government.

Lucy Smith, senior investment manager at investment management firm Killik & Co, said: “Today the 10-year UK gilt yield has risen above 5 per cent for the first time since 2008. This is bad news for Reeves as she attempts to contain government borrowing costs whilst encouraging growth.”

The chancellor was already dealing with rising inflation, up from 3 per cent to 3.3 per cent in the most recent official figures, and has faced speculation that the prime minister may look to remove her in a shake-up of his team.

Retailers are warning of rises in the cost of food and fuel, a further blow to those on the lowest incomes who were already stretched. Local council elections on May 4 are expected to see a Labour battering at the polls.

The International Monetary Fund (IMF) recently revised UK growth forecasts for the year down from 1.3 per cent to 0.8 per cent. Some economists fear she may have to find new tax rises.

Ms Smith added: “The Iran war has caused oil prices to spike, with the price of oil remaining above $100 a barrel, up from around $60 in December. The UK is a net importer of oil, so this increase is likely to create a supply-side inflationary shock, worsening the UK’s inflationary outlook. The combination of higher inflation and lower growth presents a significant challenge for the chancellor and may result in further tax rises or reduced spending in the next budget later this year.”

City insiders say that political instability within the UK government, particularly surrounding the Peter Mandelson vetting inquiry, may have also contributed to rising yields, as instability makes investors less willing to hold government debt.

Some spy opportunities for retail investors, since government debt is guaranteed. Bonds can be bought via all major investment platforms and held in tax-free ISAs.

Alan Miller at investment firm SCM Direct said: “Long gilts at 5 per cent plus are the best deal retail savers have had in years. Wrap it in an ISA, and you keep the lot.”

Ms Reeves has been trying to create so-called “headroom”, which means the UK’s finances remain within the guidance she has given to Parliament. Some experts argue she has handled this well.

Andrew Goodwin at Oxford Economics says: “We calculate that if gilt yields and market expectations for bank rate stay where they are now, it would knock about £7.5bn off the chancellor’s £23.6bn headroom at this autumn’s Budget. But this won’t force the chancellor to take corrective action. Indeed, it demonstrates that her decision to increase headroom at the 2025 Budget was a wise one because it has given her the room to absorb this unexpected shock without having to respond with higher taxes.”

The Bank of England’s Monetary Policy Committee (MPC) meets on Thursday and is expected to hold interest rates at 3.75 per cent.

Before the Iran war, it was widely expected that the Bank would cut rates two or three times this year, leading to lower mortgage costs.

Critics say government policy is as much to blame as global events.

Kallum Pickering, chief economist at Peel Hunt, wrote in a note: “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. Unsurprisingly, it no longer takes much to spook UK government debt markets.”