Gilts are UK government bonds, so-called because their certificates once had gold edges. They are issued by the government, via the Debt Management Office, to fund government borrowing. The problem at the moment is that the market interest rate, or yield, has increased, particularly for long-dated gilts.
Why does this matter?
The higher that gilt yields go, the more the government must ultimately pay in debt interest. Already, it is predicted that it will spend £111 billion this year on debt interest, much more than the budgets of most government departments.
Gilt yields are a key input for the Office for Budget Responsibility (OBR) in assessing whether Rachel Reeves will meet her fiscal rules. Higher gilt yields could force the chancellor into spending cuts or tax increases.
What kind of interest rates are we talking about?
On Friday, the yield on ten-year gilts was 4.65 per cent, close to its highest since early 2008, The 30-year gilt yield was 5.38 per cent, in its case near its highest since 1998.
Why have gilt yields risen recently?
Bond markets globally have reacted adversely to Donald Trump’s “big, beautiful” budget, which will add significantly to US government debt and has been criticised by Elon Musk as he leaves the White House. Moody’s, the credit-rating agency, recently downgraded US government debt, further undermining confidence.
Bond markets have also been troubled by the US president’s on-off tariffs, which they think will make it harder for the Federal Reserve, America’s central bank, to cut interest rates.
Does that mean America has even higher government bond yields than the UK?
No. UK ten-year gilt yields are the highest among advanced economies. America still benefits from a “safe haven” advantage, despite Trump, so US ten-year Treasury yields are 4.42 per cent.
Other G7 countries have even lower yields: 3.52 per cent for Italy, 3.22 per cent in Canada, 3.19 per cent France, 2.53 per cent Germany, and 1.48 per cent for Japan. Even Greece can borrow more cheaply than the UK. Its ten-year bond yield is 3.26 per cent.
President Trump with Steve Witkoff. London’s financial markets are among those where bonds have reeled in the face of Trump’s budget
DANIEL TOROK/WHITE HOUSE
Why are UK borrowing costs higher than for other countries?
It was not always the case. Gilt yields were similar to the G7 average until three years ago, when the markets were faced with “Trussonomics”, the mini-budget of September 2022 delivered by Kwasi Kwarteng under Liz Truss, the then-prime minister.
Although Truss’s period as prime minister was very short, and Kwarteng was quickly replaced as chancellor by Jeremy Hunt, what markets described then as the “moron premium” has endured, and UK borrowing costs have remained higher than the G7 average.
Why is that?
As well as high levels of government borrowing, the UK, like America, runs a balance of payments deficit. The two are sometimes known as the “twin deficits” and, according to Sanjay Rana, an economist with Deutsche Bank in London: “The UK’s twin-deficit position mirrors that of the US, with one major exception: we lack the growth seen in the US. One way to shake gilts off their post mini-budget crisis funk is for the UK to showcase a period of strong and sustainable growth.”
Is inflation also a problem?
Yes. Financial markets are sceptical of the Bank of England’s ability to get inflation back down to its 2 per cent target and keep it there. Inflation is currently 3.5 per cent and wage rises averaging 5.5 per cent are inconsistent with achieving the target. Although the Bank has cut interest rates four times from their 5.25 per cent peak, this has not fed though into lower long-term gilt yields.
Rana said: “Investors have long seen the UK as a problem child for missing its inflation target.”
Who owns gilts, and is that part of the problem?
Yes. The International Monetary Fund, in its latest assessment of the UK economy, highlighted increased ownership of gilts by hedge funds, which are less likely to be stable long-term investors.
“There has been a longer-term trend in place here due to the demise of defined-benefit pensions, and the funding gap in such legacy schemes has shrunk, reducing the demand for longer-term gilts,” said Philip Shaw, an economist with Investec. “An interesting footnote is that the spread between ten-year and 30-year gilt yields was negative for a long period in the 1990s and 2000s, when a combination of heavy demand from pension funds and a low debt-to-GDP [gross domestic product] ratio resulted in a relative scarcity of long-dated gilts. How times change!”
The Debt Management Office, which is responsible for gilt issuance, is switching to shorter maturities — fewer long gilts — to restore the balance between supply and demand and bring down yields. The Bank is undertaking a programme of so-called quantitative tightening (QT), reversing quantitative easing by selling gilts. Last month it scrapped a planned auction of long-dated gilts, replacing it with a sale of shorter-dated bonds. So far, these moves have not made much difference.
