Why are UK borrowing costs rising?

UK borrowing costs have increased as selling pressure hit government bonds, pushing yields on some maturities to their highest levels in years. The 10-year bond yield reached its highest level since 2008, while the 30-year yield hit its highest point since 1998.

Governments borrow by issuing bonds to finance spending they cannot cover through tax revenue. In the UK, these securities, known as “gilts,” are generally seen as low risk, but investors are demanding higher returns amid concerns that inflation could stay elevated for longer.

The main risks markets are watching

The move is not limited to the UK; borrowing costs are also rising in the US, Japan and Europe. Among the factors being priced in by investors are:

  • Expectations that developments in the Middle East could keep oil prices high,
  • The risk that inflation remains above expectations for longer than anticipated,
  • Rising government borrowing levels,
  • Growing loan demand from major technology companies looking to finance artificial intelligence investment.

When inflation rises, the real value of the fixed payments bonds will deliver in the future falls. As a result, investors demand higher yields, which increases selling pressure on existing bonds.

How could higher yields affect budget decisions?

The rise in yields is making long-term government borrowing more expensive. That is increasing pressure on public finances ahead of preparations for the first budget to be presented by Prime Minister Andy Burnham and Chancellor John Healey on 28 October.

The government’s own fiscal rules leave limited room to manoeuvre. If the cost of servicing debt rises, less money may be available for other spending priorities within the same budget envelope. That could mean lower support for households under cost-of-living pressure, or funding those measures through tax rises.

Options remain, but the room is narrowing

According to experts, none of these are final decisions, but policy choices. The Treasury could also create room in the budget by cutting other spending lines to raise additional resources.

Possible effects on mortgages and pension income

The rise in bond yields could put upward pressure on costs, especially for new fixed-rate mortgage products. Analysts say lenders may raise rates on new deals as their own funding costs increase.

Even so, the picture is seen as different from the sharp shock seen after September 2022, following Liz Truss’s mini-budget. At that time, rates jumped within days and banks quickly withdrew many mortgage offers because they were struggling to price them.

Who could benefit?

Rising yields could create a more favourable environment for annuities, insurance products that provide lifetime retirement income. As a result, the current market move may add pressure on the mortgage side while offering better conditions for people looking to lock in retirement income with a one-off product.