Is The UK Sleepwalking Toward A Debt-Based Crisis?

Bank Of England In The Spotlight

Last week, Ed Conway at Sky News noted that while the Bank of England had just cut interest rates, the borrowing costs were not falling. More specifically, borrowing costs were rising.

Ed noted that the UK 30-year government bond yield (Gilts) was now higher than the peak experienced during the chaos surrounding the Truss mini-budget.

The UK 30-year government bond yield is now at levels not seen since 1998.

While 30-year government bond yields are rising in most G7 countries (Japan being the exception), the rate of increase within the UK accelerated following the Truss budget and has continued to outpace the rest of the G7.

While the Bank of England can cut rates at the front end of the yield curve, it is the market that determines rates in the medium to long term.      

The market is signalling that uncertainty about the long-term fiscal viability of the UK economy and government spending, in the period since the Truss budget, has not diminished.

More concerning, the actions of the market suggest that the uncertainty surrounding UK growth, inflation, public deficit and debt servicing costs is increasing.

Interest Rates And The Bank Of England 

That’s not helped by the Bank of England lowering interest rates in an environment of increasing inflation.

That doesn’t sit well with their mandate and suggests that there may be something the Bank of England is seeing in the labour market or economy that, despite inflation between 3 and 4%, warrants a rate cut.

In addition, government borrowing is rising and, in the period since the Great Financial Crisis, has outstripped the increase in private debt.

In short, UK government debt is no longer considered ‘risk-free’. On that basis, the market is demanding higher rates to reflect the increasing risk.

The balance of probability is that UK government bond yields will likely continue to push higher.

Elevated yields can restrict business and consumer investment and spending, slowing economic growth.

The government will pay more interest on new debt, adding more strain to public finances. That may require tax rises or spending cuts to stay within fiscal rules.

In his commentary, Ed noted that everyone he had spoken to said they were not quite sure why the borrowing costs were rising. That it was a mystery.

Let’s hope that Ed had not spoken to anyone at the Bank of England or the Treasury.