UK borrowing costs rise as ‘stagflation’ fears stalk gold market

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Concerns about the stagnation of the UK economy and accelerating inflation are unnerving investors, pushing borrowing costs to their highest premium over German debt yields since 1990.

The spread between the two countries’ bonds has risen above 2.3 percentage points, the highest since German reunification and eclipsing the peak reached after Liz Truss’ ill-fated “mini” Budget two years ago.

“Concerns about stagflation have returned to the UK bond market,” said Robert Dishner, senior portfolio manager at Neuberger Berman.

He added that investors were also “a little nervous” about the scale of the Labor government’s borrowing plans, which could rise further if weak growth curbs tax revenues.

The bond market moves come ahead of the Bank of England’s final policy meeting of the year on Thursday, with investors betting that persistent inflation will prevent the central bank from cutting its benchmark rate, despite stagnating inflation. economy.

Recent data showed that GDP unexpectedly contracted for the second consecutive month in October.

Rising bond yields have also brought government borrowing costs back close to a one-year high hit last month after Chancellor Rachel Reeves’ October budget, which briefly rattled investors by accelerating Treasury debt issuance plans.

Ten-year bond yields rose 0.05 percentage point to 4.57 per cent on Wednesday following figures showing UK inflation accelerated to 2.6 per cent in November.

“Higher borrowing costs continue to undermine the UK’s fiscal position,” said Mark Dowding, chief investment officer at RBC Bluebay Asset Management.

“If bond yields rise above the levels seen during Truss’s tantrum, Rachel Reeves could end up reneging on more promises and be forced to raise taxes or cut spending to allay concerns around debt sustainability.”

The recent rise in yields from below 4.2 percent two weeks ago came as traders bet the Bank of England will now make just two quarter-point cuts next year, down from four expected in October.

The data “calls into question the Bank of England’s ability to cut rates,” said Craig Inch, head of rates and cash at Royal London Asset Management.

The difference in yields with the eurozone is also largely due to investor expectations that the European Central Bank will reduce borrowing costs much faster than the Bank of England as it grapples with an even sharper slowdown in growth.

Additionally, the rise in yields reflects a sell-off in the US Treasury market, where investors have lowered their expectations for Federal Reserve rate cuts in 2025 since Donald Trump’s election victory last month.

Economists have long expected a rebound in price pressures in the UK towards the end of the year, due to so-called base effects, as energy costs fell a year ago, the point of comparison when calculating annual inflation.

However, Bank of England policymakers are also concerned about the scale of price rises in the services sector, as well as rapid wage growth.

Services price growth of 5 percent in November was higher than the Bank of England’s own forecast of 4.9 percent and well above the rate considered compatible with the bank’s 2 percent inflation target. central.

Separate figures earlier this week showed average weekly earnings in the UK, excluding bonuses, rose faster than expected, up 5.2 per cent in the three months to October.

Higher public spending and borrowing in Reeves’ budget are also likely to increase inflationary pressures.

Those measures will add 0.75 percentage points to GDP and about 0.5 percentage points to consumer price inflation in about a year, according to the Bank of England’s latest set of forecasts last month.