The pound has fallen to its weakest level in more than a year, while UK borrowing costs surged to their highest since 2008, sparking fresh warnings about the economic challenges facing the government.
Economists have cautioned that the rise in borrowing costs could force Chancellor Rachel Reeves to consider tax increases or spending cuts to adhere to fiscal rules, further tightening pressure on public services and businesses.
Speaking in Parliament, Treasury minister Darren Jones dismissed the need for urgent government action, insisting markets were operating “in an orderly way.” But Shadow Chancellor Mel Stride criticized the government’s approach, warning that “higher debt and lower growth are understandably now causing real concerns among the public, among businesses, and in the markets.”
Why borrowing costs are climbing
UK government borrowing costs are tied to the yield on gilts, which have been climbing steadily in recent months. The 10-year gilt yield touched 4.9% earlier this week—its highest level in 16 years—before easing slightly by mid-afternoon.
Rising yields mean the government faces higher interest payments on its debt, leaving less room for spending on services or infrastructure. Mohamed El-Erian, chief economic adviser at Allianz, said the trend could slow economic growth and “leave the chancellor with tough decisions on taxes or spending.”
While UK borrowing costs have been rising, similar trends have been observed in the US and other major economies, reflecting global investor concerns about inflation and debt levels.
“It may be a global sell-off, but it creates a singular headache for the UK chancellor,” said Danni Hewson, head of financial analysis at AJ Bell. “Balancing fiscal rules with increasing demand for public spending will not be easy.”
Despite this, the pound fell 0.9% against the dollar to $1.226 on Thursday—a counterintuitive move, as higher yields typically support sterling. Economists said investor concerns about the UK’s sluggish growth prospects were weighing on the currency.
Stagnation adds to fiscal pressure
Recent economic data has painted a bleak picture for the UK. Growth stagnated between July and September last year, while inflation in November rose at its fastest rate since March. The Bank of England kept interest rates steady at 4.75% in December, citing uncertainty, but acknowledged that economic performance had been weaker than expected.
Sarah Breeden, deputy governor of the Bank of England, said the bond market movements had been “orderly” but cautioned that the situation required monitoring. “So far, so good,” she said during a speech at the University of Edinburgh.
Impact on mortgages and businesses
The slow but steady rise in borrowing costs contrasts with the turmoil seen after Liz Truss’s mini-Budget in September 2022. While Truss’s policies triggered a sudden spike in yields, this time the increase has been gradual, largely driven by global market trends and concerns about debt levels.
However, Simon French, chief economist at Panmure Gordon, said comparisons with the Truss era are not entirely fair. “This time, there is global anxiety about debt pushing yields up everywhere,” he explained. “But there’s also a dim view of the growth impact from Rachel Reeves’ Budget, which is slowing rather than accelerating the economy. That is her responsibility.”
What’s next for the UK economy?
The government has declined to comment on its spending or tax plans ahead of the official borrowing forecast from the Office for Budget Responsibility, due in March. Economists warn that if borrowing costs remain elevated, Reeves may face limited options to manage the economy without breaking fiscal rules or impacting public services.