By Dhara Ranasinghe and William Schomberg
LONDON (Reuters) -Britain’s 30-year borrowing costs rose to their highest levels since 1998 and sterling slid over 1.5% on Tuesday, highlighting growing investor anxiety about the UK’s ability to keep its finances under control.
The selloff in British bonds, known as gilts, coincided with selling across other major bond markets, where the focus is firmly on rising debt levels.
But weakness in sterling pointed to vulnerability in UK markets at a time of increasing concern about the Labour government’s ability to exercise fiscal constraint.
“The UK has had a perilous (fiscal) backdrop and that’s going to continue,” said Lloyds FX strategist Nick Kennedy.
“Over the summer, there has been a bit of a risk premium built into the rates market. Investors are now wanting more of a risk premium for sterling as well.”
Thirty-year gilt yields rose to 5.723%, their highest since May 1998, and sterling was by far the day’s weakest performing G10 currency against the dollar, down over 1.5% at one point.
It was last off 1.0% at $1.34, its biggest daily fall since June, and at 86.98 pence per euro, 0.6% softer.
CHALLENGES AHEAD
Prime Minister Keir Starmer on Monday reshuffled his top team of advisers, moving finance minister Rachel Reeves’s deputy Darren Jones into his Downing Street office to better coordinate policy delivery.
Starmer also appointed a former Bank of England deputy governor, Minouche Shafik, as his chief economic adviser, to bolster economic expertise ahead of what is expected to be a difficult budget later this year, but also sparking headlines that the move had weakened Reeves.
Analysts said the changes on the first day of parliament after the summer recess renewed focus on the economic challenges given heavy levels of borrowing, slow economic growth and the highest inflation rate among the G7 major Western economies.
Santander said it now expects the Bank of England to hold rates at 4% until the end of 2026, having previously expected two cuts next year.
With the budget unlikely to come before November, Britain faces weeks of speculation about tax rises, potentially dampening investment and consumer confidence.
And higher borrowing costs are making the government’s task harder.
“Everyone wants to feel assured that the government finances are in a sound position but as yields go up … the fiscal black hole has grown and grown and grown,” said Mark Dowding, fixed income CIO at RBC BlueBay Asset Management.
Britain is not the only country suffering fiscal worries.
France’s 30-year government bond yields surged to their highest levels in over 16 years on Tuesday, driven by fiscal concerns and political instability. Japan’s bonds have sold off heavily this year on concern about rising debt.
In one reassuring sign, Britain sold a record 14 billion pounds ($19 billion) of new 10-year bonds on Tuesday, after attracting 141.2 billion pounds in orders from investors.
The Bank of England is also expected soon to slow the pace at which it shrinks its 558 billion-pound ($754 billion) holdings of government bonds, a process called quantitative tightening.
Dowding at BlueBay wanted them to go further.
“The Bank of England has got to stop QT right now,” he said. “Many investors including ourselves have been saying to the Bank of England they are making life worse, not better. Stop doing this.”
(Reporting by Dhara Ranasinghe, William Schomberg Naomi Rovnick and Jaspreet Kalra; additional reporting by Kate Holton and Yoruk Bahceli; editing by Alun John, Karin Strohecker, Mark Heinrich and Kevin Liffey)
