UK government borrowing costs have risen historically after a blow to the gilts

UK government borrowing costs are on track for one of their biggest monthly hikes ever – and mortgage rates will rise too – following the bond market collapse triggered by Chancellor Kwasi Kwarteng’s fiscal policy announcement last week.

The 10-year benchmark government bond yield is up 1.26 percentage points to 4.1 percent so far in September, marking one of the largest monthly jumps on record in Refinitiv’s data, dating back to 1979. Bond yields are rising as prices fall. The two-year yield has also risen, from 3 percent at the end of August to 4.3 percent, the highest in more than 14 years.

The monthly decline remains historic, even as gold prices rose early Tuesday.

“The steps are just extraordinary,” said Vivek Paul, UK chief investment strategist for the BlackRock Investment Institute. “The market has passed its verdict [on the government’s fiscal plans] and that’s not good.”

Gold market turmoil has also hit the UK housing sector, with leading mortgage lenders such as Virgin Money and Halifax cutting new home loans in response to rising yields and volatility.

Ray Boulger, an analyst at mortgage broker John Charcol, said he expected “very few mortgage deals will be available with rates below 5 percent” starting next week due to the surge in gold yields.

Most of the gilt sell-offs have taken place during the last two trading sessions, after Kwarteng on Friday announced the largest package of tax cuts since the 1970s, alongside much-anticipated energy subsidies to protect households from rising gas prices. Bond investors have been hesitant about the additional borrowing planned to pay for the plans, including an additional £70 billion in debt sales in the current fiscal year alone.

Change in 10-year gold yield from 1979 to 2022

The historic losses for gilts, which will lead to a significantly higher government interest bill if they persist, have coincided with a global decline in government debt. However, losses on UK bonds have outpaced rivals such as German Bunds and US Treasuries.

The difference between UK and German 10-year borrowing costs has widened to 2 percentage points, from 1.3 percentage points so far this month.

To further increase the pressure on government bonds, Kwarteng’s announcement came a day after the Bank of England confirmed that it will sell the government bonds in its portfolio that it had acquired under previous quantitative easing stimulus programmes. a process known as quantitative tightening. The BoE said it plans to reduce the size of its holdings by £80 billion to £758 billion over the next 12 months.

“It’s the extra supply of gilts that really scares the markets,” said Jim Leaviss, head of public fixed income at M&G Investments. “Energy subsidies, tax cuts and QT all coming to market at the same time is a huge shock.”

The additional bond issuance announced to fund Kwarteng’s policy changes will make it difficult to proceed with QT, which is scheduled to start next month, according to Paul.

“The optic of gilt sales is starting to look really bad,” he said.

Spread in 10-Year Bond Yields

The long-term nature of Kwarteng’s tax cuts, as opposed to larger but temporary support for utility bills, has been the main concern for some investors.

“Because of the tax cuts, not the energy bill support, the UK deficit will be significant five years from now, raising questions about fiscal sustainability,” said Dean Turner, an economist at UBS Wealth Management.

Additional reporting by Emma Dunkley

Leave a Comment