Bond markets price in fiscal risk as oil-driven inflation and a looming Labour defeat push borrowing costs higher
Britain’s long-term government borrowing costs surged to their highest point in nearly 30 years on Tuesday, driven by escalating tensions in the Hormuz strait and mounting concern over a sustained inflationary environment — with political instability at home adding a further layer of risk for bond markets still scarred by the 2022 mini-Budget crisis.
Thirty-year gilt yields climbed as much as 0.14 percentage points to 5.79% — a level last seen in 1998 — before easing slightly to 5.74%. The yield on the 10-year gilt rose 0.15 percentage points to 5.11%, approaching the 18-year peak of 5.12% recorded earlier during the Iran conflict, before settling at 5.06%. Yields move inversely to prices.
The sell-off has been driven by expectations that the Bank of England will need to raise interest rates to contain inflation driven by oil prices trading well above $100 a barrel. Traders now anticipate two to three quarter-point rate rises before year-end — a stark reversal from earlier forecasts that had pointed toward cuts to stimulate growth.
The UK already carries the highest borrowing costs among G7 nations, with debt interest payments exceeding £100 billion annually. Gilts have been the worst-performing major bond market since the conflict began, reflecting elevated pre-war inflation and the UK economy’s heightened sensitivity to energy price shocks.
Political risk compounds the pressure
The market turbulence is unfolding against a backdrop of acute domestic political uncertainty. Labour is widely expected to suffer significant losses in local elections in England on Thursday — with projections pointing to as many as 1,900 council seat losses — alongside devolved polls in Scotland and Wales. Reports have also emerged of Labour backbenchers preparing an open letter pressuring Prime Minister Keir Starmer to set out a timetable for his departure, drawing comparisons with the internal campaign that preceded Sir Tony Blair's exit in 2006.
Nigel Green (pictured right), chief executive of financial consultancy deVere Group, warned that gilt markets remain deeply sensitive to any such political upheaval. “Markets have long memories, and in the UK gilt market, that memory is dominated by Liz Truss,” he said.
“The 2022 mini-Budget crisis is still the benchmark for what happens when fiscal credibility is questioned. Yields surged, long-dated gilts were hit hardest, and the Bank of England was forced into emergency action to stabilise the system.”
During that episode, 30-year gilt yields briefly surged above 5%, triggering severe stress in liability-driven investment strategies used by pension funds and forcing the Bank to intervene with emergency gilt purchases. Green cautioned that conditions today carry echoes of that period.
“Any sign of instability around Prime Minister Keir Starmer or pressure on Chancellor Rachel Reeves immediately feeds into concerns about whether fiscal discipline could weaken,” he said. “If Labour suffers a heavy defeat and internal divisions intensify, gilt markets will start assigning a higher probability to looser fiscal policy, whether through increased spending, diluted rules, or political concessions.”
The UK enters this political flashpoint with limited room for manoeuvre. Public debt remains close to 100% of GDP, borrowing continues at elevated levels, and gilt issuance is expected to exceed £250 billion this fiscal year.
Attention is likely to centre on the long end of the yield curve, where maturities between 10 and 30 years are most exposed to concerns about supply and long-term fiscal sustainability. “The long end is where the damage showed up during the Liz Truss episode, and it is where it would show up again,” Green said. “Investors demand a higher term premium when confidence slips, and that drives yields sharply higher in those maturities.”
Sterling is also in focus. Green warned that any erosion of confidence linked to leadership uncertainty or fiscal loosening would likely weaken the pound, feeding imported inflation and reinforcing upward pressure on gilt yields. “Currency and bonds move together in these situations,” he said. “A weaker pound lifts inflation expectations, and that pushes gilt yields higher. It becomes a feedback loop that is difficult to contain once it starts.”
“The combination of a potentially massive electoral setback, an organised push against Starmer, and questions over how firmly Reeves can hold the fiscal line creates a clear risk signal for UK bond markets. If those pressures build after the vote, gilt investors will move quickly, pricing in higher borrowing, demanding greater compensation for risk, and pushing yields higher in a way the UK can ill afford.”
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