Faisal Islam: Britain’s rising borrowing costs are a problem for Rachel Reeves

The government is “on course” to miss its budget borrowing targets after interest rates for long-term borrowing in Britain hit their highest level this century, economists have warned.

The official forecaster, the Office for Budget Responsibility, will next month begin the process of updating its forecast, which will be presented to Parliament in late March.

According to Ruth Gregory from Capital Economics, rising borrowing costs mean “there is a significant possibility that the OBR will decide that the Chancellor, Rachel Reeves, is about to lapse her key fiscal rule”.

The yield on 30-year gilts reached 5.25% on Tuesday, surpassing the previous high reached in October 2023.

The government generally spends more than it taxes. To make up the difference he borrows money, but has to pay it back – with interest.

One way to borrow money is to sell financial products called bonds.

A bond is a promise to repay money in the future. Most require the borrower to make regular interest payments.

UK government bonds – known as “gilts” – are generally considered very safe, with low risk that the money will not be returned.

Gilts are mainly purchased by financial institutions in the UK and abroad, such as pension funds, investment funds, banks and insurance companies.

Repaying the existing national debt in the UK is estimated to cost 7% of total public expenditure, but this forecast was based on low government borrowing rates.

Number 10 said there is “no doubt about the government’s commitment to economic stability” and “meeting our financial rules is non-negotiable”, adding that only the OBR’s forecast is an accurate estimate of the government’s room for manoeuvre. Is.

The clear signal from the government is that although they will not have a second budget in March, any necessary adjustments will have to be made in terms of some new expenditure cuts.

This morning, £2 billion of UK 30-year government debt was sold at an effective interest rate of 5.18%.

The Office of Debt Management, which is a part of the Treasury, has effectively paid the highest interest rates for these long-term loans since 1998.

Markets are raising their eyebrows about the level of debt around the world and bond issuance, especially from countries like the UK and US, and additionally, the possibility of inflation above target.

This type of thirty-year loan does not have a direct impact on lending rates for households and companies. This type of loan is a specialist tool used by pension funds. But today’s auction highlights the rise in lending rates over the past month.

For example, the more general gilt market moves have not yet led to significant changes in fixed mortgage rates. But if this, as is likely, continues into next month, it will impact the Office for Budget Responsibility’s new forecast.

The rate hike has affected the US and UK more, and continental Europe less. The post-Budget rise in UK market rates subsided by early December. But now British lending rates are rising along with American ones.

Stagnant growth and sticky inflation have raised concerns about so-called “stagflation”. Markets are beginning to question the inflationary effects of incoming President Trump’s trade and tax policies.

Although this is not a crisis, it is a new reality. Markets are questioning whether Britain can really sustain high growth rates and controlled inflation. And these questions are now emerging against the backdrop of Trump’s trade turmoil, which is hitting global markets for borrowing. It’s been a bumpy start to 2025.