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What is happening in the bond markets?
A bond is a bit like an IOU that can be traded on financial markets.
Governments typically spend more in taxes than they collect and so borrow money to cover the deficit, usually by selling bonds to investors.
In addition to eventually repaying the value of the bond, governments pay interest at regular intervals so that investors receive a stream of future payments.
UK government bonds – known as “gilts” – are normally considered very safe, with little risk that the money will not be repaid. They are mainly purchased by financial institutions, such as pension funds.
Interest rates – called yields – on government bonds have been rising since around August.
The yield on a 10-year bond has reached its highest level since 2008, while the yield on a 30-year bond is at its highest since 1998, meaning it is costing the government more to borrow over the long term.
The pound sterling has also lost value against the dollar in recent days. On Tuesday it was worth $1.25 but is currently trading at $1.23.
Why are bond yields rising?
Yields are not only increasing in the UK. Borrowing costs have also increased in the United States, Japan, Germany and France, for example.
There is great uncertainty about what will happen when President-elect Donald Trump returns to the White House later this month. He has pledged to impose tariffs on goods entering the United States and reduce taxes.
Investors fear this could lead to more persistent inflation than previously thought and therefore interest rates may not fall as quickly as they had expected.
But in the UK there are also concerns that the economy is underperforming.
Inflation is at its highest level in eight months – reaching 2.6% in November – above the Bank of England’s 2% target – while the economy has been in contraction for two months running .
Analysts say it is these broader concerns about the strength of the economy that are driving down the pound, which typically rises when borrowing costs rise.
How does this affect me?
Chancellor Rachel Reeves has promised that all day-to-day spending should be funded by taxes, not borrowing.
But if it needs more money to pay off higher borrowing costs, that eats up more tax revenue, leaving less money to spend on other things.
Economists have warned that this could mean spending cuts that would hit public services, and tax hikes that could hit citizens’ wages or the ability of businesses to expand and hire more.
The government has committed to only having one tax event per year, during which it can raise taxes, and that is not expected until the fall.
So if higher borrowing costs persist, it’s more likely we’ll see spending cuts before then.
Some people may be wondering about the impact of rising government bond yields on the mortgage market, particularly after what happened after Liz Truss’ September 2022 mini-budget.
Although yields are higher today than they were then, they increased slowly over a period of months, whereas in 2022 they will skyrocket in a matter of days. This rapid rise has led lenders to quickly close deals while trying to determine what interest rate to charge.
Analysts and brokers say the current malaise in the markets is having some effect on mortgage pricing. Many expected rates to drop at the start of the year, but lenders instead held off on cutting them to see what would happen.
What happens next?
The Treasury said emergency intervention in financial markets was not necessary.
He said he would not make any spending or tax announcements ahead of official borrowing forecasts from his independent watchdog, the Office for Budget Responsibility (OBR), due on March 26.
If the OBR says the chancellor is still on track to meet her self-imposed fiscal rules, that could calm markets.
However, if the OBR said that due to slower growth and higher interest rates than expected, the chancellor is likely to break its fiscal rules, that would potentially pose a problem for Reeves.
