UK long-term borrowing costs have reached a 27-year high, which industry experts have blamed on the government's tax and spending plans alongside sluggish economic growth.
The yield on 10-year gilts has reached 4.9%, the highest since 2008, while 30-year gilts yields hit their highest level since 1998.
Financial markets are still expecting two interest rate cuts by the end of the year, and there’s still more than a 60% chance of a cut in February. However, financial markets are now predicting only 40bps worth of rate cuts for 2025 compared to 60bps at the end of December.
But how will rising borrowing costs impact different elements of financial services?
Interest rates
Oliver Faizallah, head of fixed income research at Charles Stanley, stated: "Market views on Bank of England cuts are more bearish than the Bank themselves, and the market is now looking at only 40bps worth of rate cuts for the year vs 60bps at the end of December.
“Higher gilt yields have increased borrowing costs, which has eroded most, if not all the UK government's fiscal headroom. With poor growth numbers the Labour government may be forced to reduce spending, increase taxes, or increase borrowing.
“We are potentially looking at a stagflationary environment (higher inflation and poor growth) or a recessionary environment (growth falling to such an extent that inflation drops as well) in the UK."
Susannah Streeter, head of money and markets at Hargreaves Lansdown, commented: "Already there was wariness surrounding the level of UK debt and the gilt markets are now in the eye of the storm.
"In the UK, there is also particular concern brewing about stagflation taking hold, given that inflation has been creeping up and pay growth is still hot, while the economy has been stagnating. There are concerns this may limit the interest rate reductions by the Bank of England this year."
However, Streeter believes higher gilt yields are unlikely to have an immediate impact on decisions by the Bank of England when it comes to interest rate cuts, as financial markets are still expecting two interest rate cuts by the end of the year. In fact, if the government is forced to increase taxes or reduce spending, which Rachel Reeves will want to avoid, Streeter says it "could dampen down economic activity and make interest rate cuts more likely".
Pensions and annuities
Helen Morrissey, head of pensions analysis at Hargreaves Lansdown, said: “Falling bond prices could cause concern for retirees who are coming up to retirement invested in lifestyling arrangements. These move the member out of equities and into bonds the closer they get to retirement. However, there’s no need for knee-jerk reactions. Those who intend to remain invested through income drawdown have the ability to hold fire on drawing an income until the markets have recovered. Those who are looking to annuitise some or all of their pension pot will also likely find that the spike in gilt yields can push the income available from an annuity upwards, softening the impact. It’s also worth saying that you don’t have to annuitise all your pension at once. You can do it in stages throughout retirement securing a guaranteed income as your needs evolve while leaving the rest invested in drawdown where it can grow.”
David Brooks, head of policy at independent consultancy Broadstone, agreed that the impact on pension schemes likely to be contained. He said: "LDI funds have been actively managing their cash positions in response to this shifting investor sentiment and market volatility, but there don’t seem be any systemic issues at play. Improvements to collateral management and waterfall structures since the 2022 yield crisis have significantly strengthened market resilience and ensured schemes are better prepared to handle fluctuations.”
Mortgages
Sarah Coles, head of personal finance at Hargreaves Lansdown, commented: “The rise in gilt yields always raises the spectre of rising fixed mortgage rates, because they’re very responsive to changes in interest rate expectations. Rates have already crept up very slightly, but there’s no need for prospective borrowers to panic at this stage.
"It’s worth noting that although the bond markets have thrown a wobbly, it hasn’t particularly altered expectations of what the Bank of England is likely to do to rates. The market is still pricing in just over a 60% chance of a rate cut in February – it has moved from 66% to 64%, but that’s nothing to frighten the horses.
"Very slightly higher rates have been brought in by some mortgage lenders, who had to secure a fixed rate in the swap markets while they’re more expensive, but as yet there’s nothing more widespread. This is likely to filter into more deals, but it’s not yet clear how long this disruption in the bond markets will last.
"The bond market in the UK reacted dramatically to news out of the US – more so than other markets around the world. In the coming days, this could subside if the bond markets decide they’ve got a bit ahead of themselves. There are no guarantees, but the strength of the immediate reaction means there’s room for the markets to gain a bit of perspective. If that happens, we’ll see yields drop again, and mortgage rates could ease.
"Of course, there are no guarantees If more worrying news comes out of the US, or fears of stagflation spread, bond yields could remain higher, and if this happens, there’s more of a chance it will be reflected in more widespread higher mortgage rates.”
