UK government borrowing costs have climbed to their highest levels in almost two decades, as rising oil prices and disruption to global energy supplies fuel concerns that inflation could remain elevated and interest rates may have to stay higher for longer.
The yield on the benchmark 10-year gilt rose seven basis points to 5.223 per cent on Tuesday, its highest level since June 2008.
Gilt yields rise when bond prices fall, signalling a sharp sell-off in UK government debt and increasing the cost of financing for the Treasury.
Longer-dated borrowing costs came under even greater pressure. The yield on the 30-year gilt rose nine basis points to 5.88 per cent, its highest level since March 1998.
The move formed part of a broader global bond sell-off as investors reassessed the outlook for inflation, interest rates and government borrowing.
Japan’s 10-year government bond yield reached 3 per cent for the first time since September 1996, while Germany’s 10-year borrowing cost rose two basis points to 3.34 per cent, its highest level in 15 years.
At the centre of investors’ concerns is the renewed rise in energy prices. Higher oil and gas costs threaten to slow the progress made by central banks in bringing inflation back towards target, potentially limiting the scope for interest-rate cuts.
Brent crude, the international benchmark, rose more than 1 per cent to about $91.69 a barrel as the conflict in the Middle East continued to disrupt energy markets.
Fresh evidence of inflationary pressure emerged from Germany, where preliminary data showed consumer price inflation accelerating to 2.9 per cent in August from 2.8 per cent in July, driven largely by a 10.5 per cent increase in energy prices.
The increase was nevertheless smaller than economists had expected, while core inflation, which excludes volatile energy and food costs, remained unchanged at 2.4 per cent.
The bond market is also contending with a growing supply of debt. Governments are issuing large volumes of bonds to finance public spending and investment, while major technology companies are raising substantial sums to fund their artificial intelligence programmes.
That is increasing competition for investors’ capital and adding to upward pressure on borrowing costs.
For the UK government, the rise in longer-term gilt yields is particularly significant. Higher yields increase the cost of issuing new debt and refinancing existing liabilities, potentially placing further pressure on public finances at a time when fiscal headroom is already limited.
The energy shock is being compounded by continuing disruption in the Strait of Hormuz, a critical artery for global oil and gas supplies that has been effectively closed by Iran since the US and Israel began military action against Tehran on February 28.
Shipping through the waterway remains well below normal levels.
Five commodity vessels crossed the strait on Monday, according to Kpler shipping data, compared with a recent 10-day average of 14. None of the vessels was a liquid tanker.
The United Kingdom Maritime Trade Operations agency said on Tuesday morning that a tanker had reported being struck by three projectiles while leaving the strait. No casualties or environmental damage were reported.
Analysts at Australia and New Zealand Banking Group warned that the disruption was placing increasing pressure on global oil supplies.
Satellite-tracking companies estimate that about 6mn barrels of oil a day are still moving through Hormuz, but that remains substantially below pre-conflict levels.
ANZ analysts also warned that the market’s remaining supply buffers were being eroded. US oil inventories are approaching minimum levels, while China could come under greater pressure to increase imports as seasonal demand strengthens.
The combination of tighter energy supplies, higher oil prices and heavy government borrowing is creating a difficult environment for fixed-income markets.
For investors, the central question is increasingly whether the latest energy shock will prove temporary or become embedded in broader inflation pressures. For the UK Treasury, the answer could determine how much more expensive it becomes to finance the government’s spending commitments in the years ahead.
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