(Bloomberg) -- The UK’s long-term borrowing costs surged to the highest level in more than a quarter of a century, raising the prospect of Chancellor of the Exchequer Rachel Reeves needing to raise taxes again in order to meet her fiscal rules.
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The yield on 30-year gilts climbed as much as six basis points to 5.24% on Tuesday after the first of a string of bond sales due over the coming weeks. The yield was last higher in 1998 when Tony Blair was prime minister and the Bank of England was slashing interest rates from a six-year peak to contain the global fallout from the Asian currency crisis and Russian debt default.
Today’s Labour government is ramping up borrowing in an effort to improve Britain’s public services and boost investment in large infrastructure projects. Reeves has also committed to maintain discipline but was given just £9.9 billion ($12.4 billion) of headroom against her main fiscal rule despite lifting taxes by more than £40 billion in her Oct. 30 budget.
Reeves tweaked her self-imposed fiscal rules as the new administration sought to protect its credibility with markets while allowing for more public investment. The main rule prevents the chancellor from borrowing for day-to-day spending by 2029-30, which she has said is non-negotiable. She also opted for a slightly looser debt rule than her Conservative predecessor, vowing to reduce “net financial debt” as a share of GDP by 2029-30.
“If market pricing sticks then the fiscal rules are probably going to be breached in the UK and they’re going to have to come back and do more,” said Jamie Rush, Bloomberg’s chief European economist. Reeves has insisted she will not raise taxes again, but some of her Cabinet colleagues, including Prime Minister Keir Starmer, have been less equivocal.
Capital Economics said Reeves is “within a whisker” of breaking her fiscal rule and even a modest increase in interest-rate expectations and 20-year gilt yields could wipe out the chancellor’s headroom altogether.
“Reeves could soon face a nasty choice of breaking her fiscal rules or announcing more tax rises and/or spending restraint at a time when the economy is already weak,” said Ruth Gregory, an economist at the firm.
The UK’s Debt Management Office sold £2.25 billion on 30-year notes on Tuesday, paying a yield of 5.198%. The auction gave mixed signals of demand. While its oversubscription rate was the weakest since December 2023, at a bid-to-cover ratio of 2.75, the difference between the average and lowest yield accepted — known as tail — was just 0.3 basis points, indicating solid appetite for the notes.