Bond market and borrowing costs

Government borrowing has reached its highest level in several years, but what does that mean for the UK economy and your personal pocket?

The government typically spends more money than they receive in tax, so to fill in the spaces, they borrow money. This is usually in the form of a bond between the government and investors. The government borrows money as a loan and pays interest as they pay the borrowed money back to the investor.

Government bonds are called gilts, and they are generally seen as very safe as the government has always paid them back. Gilts are often used to fund pensions.

The interest rate on these bonds - which is called the yield - has been on the rise recently. Currently, the yield on a 10-year bond is the highest it’s been since 2008, whilst the yield on a 30-year bond is the highest it’s been since the late ‘90s. This is as the value of the pound continues to fall against the dollar, which was just $1.21 in late January compared to $1.25 in early January.¹

So, what’s going on?

Yields are rising all over the world, with borrowing costs also currently high in Japan, Germany, France, and the US. ¹ There is a lot of uncertainty around what will happen with Trump, who has said he will bring in tariffs on products entering the US, which may prevent inflation levels from falling.

The UK is already struggling with inflation, which is the highest it's been in eight months while the economy continues to shrink. ¹ It is thought that fears around the economy are driving down the pound, which usually increases borrowing costs.

What does this mean for me?

The current chancellor wants to raise money from taxes, not borrowing. To pay back the increasing borrowing costs, the government will have to spend more of the tax money, which leaves less revenue for public services. This could also mean higher taxes, which affects people’s personal finances and the ability of businesses to offer pay rises and hire new employees.

Yields are higher than they were after Liz Truss's mini budget in 2022, but they have been gradually rising over months, whereas in 2022 they hurled up in a few days. ¹ That was disruptive for the housing market, because lenders were caught off guard.

The uncertainty in the market is affecting the price of mortgages, but on the other hand it’s a pretty good time to buy an annuity - a one-off purchase from an insurance company which pays you a retirement income for the rest of your life - because annuity rates usually follow gilt yields.

What now?

The government has said an emergency intervention won’t be necessary, and we won’t get any financial announcements before the official borrowing forecast from the Office for Budget Responsibility (OBR), on 26th March. If the forecast suggests that the government is in a position to stick to their original plan then the markets may calm down, but if the forecast leans towards the government having to scrap their plans and borrow more, that could be a problem.

Sources

1. https://www.bbc.co.uk/news/articles/cwyxydr7gv9o

All the information in this article is correct as of the date of publishing. The opinions expressed in this publication are those of the authors Euxton Mortgage Market. The information provided in this article, including text, graphics and images does not, and is not intended to, substitute advice; instead, all information, content and materials available in this article are for general informational purposes only. Information in this article may not constitute the most up-to-date legal or other information.

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January 2025