Bank of England, the Royal Exchange and the statue of the Duke of Wellington in the City of London on 19th February 2025 in London, United Kingdom.<\/p>\n
Mike Kemp | In Pictures | Getty Images<\/p>\n
Hello and welcome to this week’s CNBC U.K. Exchange. Gilts \u2014 short for gilt-edged securities, the term for U.K. government bonds \u2014 have sold off more aggressively than many other assets since the U.S. and Israel attacked Iran.<\/p>\n
That reflects specific factors concerning the U.K. economy and its prospects, but as the history books show, investors demanding a premium to hold U.K. government bonds over other sovereign debt is not a new phenomenon.<\/p>\n
The dispatch<\/p>\n One of the most alarming aspects of the sell-off in risk assets after the attacks on Iran, from a British perspective, has been how gilts \u2014 U.K. government IOUs \u2014 fell more sharply than bonds issued by any other G7 economy.<\/p>\n Take the 10-year gilt, the most liquid and most widely-traded of all gilt maturities and the best proxy for the U.K. government’s long-term borrowing costs.<\/p>\n At one point on Monday, before U.S. President Donald Trump raised hopes of an end to hostilities, the yield (which rises as the price falls) hit 5.115% \u2014 a level not seen since the global financial crisis<\/a> in April 2008. Immediately before the U.S. and Israel launched Operation Epic Fury on Feb. 28, it\u00a0had been 4.3%. So the conflict has added more than 80 basis points to U.K. borrowing costs.<\/p>\n Given pre-conflict forecasts from the independent Office for Budget Responsibility \u2014 that the U.K. would spend \u00a3109.7 billion ($147 billion) servicing its debt in 2025-26 and \u00a3109.4 billion in 2026-27 \u2014 this has grave implications for the government’s ability to hit its fiscal targets should the conflict remain protracted.<\/p>\n Compare the rise in U.K. borrowing costs with those of peers. The yield on 10-year German bunds<\/a> rose by just 42 basis points in the same period, while the yield on 10-year U.S Treasuries<\/a> rose by 48 basis points and on 10-year French OATs<\/a> by 64 basis points. Yields on the 10-year maturities of all G7 economies all remain substantially lower than on 10-year gilts. Only Australia, of comparable economies, has a higher yield on its 10-year debt.<\/p>\n A premium for gilts<\/p>\n There are several reasons why gilt yields have spiked more than others. One is that the Bank of England’s policy rate was already the highest of any G7 central bank and Britain’s rate of inflation is higher than that of its peers.<\/p>\n A second is that interest rate expectations for the U.K. have changed more dramatically than any other G7 economy. Before the conflict, the Bank was expected to cut<\/a> its main policy rate this month \u2014 sparking a sharper reaction in gilts. A third is that, Japan aside, no G7 economy depends more on imported gas \u2014 the price of which has surged.<\/p>\n Fourthly, investors dislike U.K. politics. The surge in energy prices has raised fears of higher spending \u2014 funded by growth-destroying tax increases or more borrowing \u2014 to support households. They also fear that May’s local elections, should the governing Labour Party perform poorly, will result in a leadership challenge to Prime Minister Keir Starmer and his possible replacement<\/a>\u00a0by a more left-wing rival.<\/p>\n But demanding a premium to hold gilts is not new. It was reinforced to the British public most starkly in recent times when, in September 2022, gilts sold off violently after Liz Truss’ government unveiled a mini-Budget<\/a> including \u00a345 billion worth of unfunded tax cuts. Market participants spoke of investors demanding a “moron premium” to hold gilts over bonds of equivalent duration issued by peers.<\/p>\n Further back, gilt yields were the highest in the G7 when the U.K. was ejected from the European Exchange Rate Mechanism in September 1992.<\/p>\n Before then, investors demanded a big premium to hold gilts for much of the mid-to-late 1970s, when the U.K. was scarred by high inflation (it hit 26.9% in August 1975 and was never below 19% that year) due to oil shocks earlier in the decade. The U.K. was ultimately forced in 1976 to seek a loan from the International Monetary Fund.<\/p>\n That led to the election of Margaret Thatcher in 1979 and some harsh economic medicine, which over time brought an improvement in the U.K.’s productivity and competitiveness.<\/p>\n It is currently hard to see any such improvement on the horizon.<\/p>\n Need to know<\/p>\n British fintech Revolut reports record annual profit as it gears up for U.S. push. The startup, which hit a $75 billion valuation in 2025, is one of Europe’s most valuable private tech companies<\/a>.<\/p>\n Britain responds to Iran war energy shock by requiring solar panels and heat pumps in all new homes. \u00a0The U.K. government on Tuesday introduced new rules<\/a> requiring all new homes in England to be installed with heat pumps and solar panels.<\/p>\n U.K. government borrowing costs hit their highest level since 2008 as inflation fears hit the gilt market. British government borrowing costs surged<\/a> to their highest since the 2008 financial crisis last week.<\/p>\n \u2014 Holly Ellyatt<\/p>\n