The UK government's long-term borrowing costs have surged to their highest level since 1998, driven by the fallout from the Iran war and speculation about Prime Minister Keir Starmer's future. The yield on 30-year government bonds peaked at 5.77% on Tuesday, surpassing the 27-year high recorded last September. This spike threatens to further inflate the government's borrowing bill at a time when the economy is already weakened by the Middle East conflict.
Market Reaction
The FTSE 100 also suffered, dropping nearly 130 points (1.27%) to 10,232.71 by 1pm. The yield on 10-year gilts, which are more reflective of new public debt costs, rose above 5% to 5.095%, heading for their highest close since 2008. While the UK is not alone—US and German yields have also risen due to ongoing disruption in the Strait of Hormuz—the domestic political uncertainty adds a unique pressure.
Political Uncertainty
Investors are nervous about the possible impact of this Thursday's local elections on the Labour Party. A poor performance could trigger a challenge to Sir Keir Starmer's leadership. Thomas Pugh, chief economist at RSM UK, warned that a change in leadership could push borrowing costs even higher. He stated: "The war in Iran has meant domestic politics has largely taken a back seat for the last couple of months. However, political risk jumped back up the agenda last week and is only likely to intensify if the local elections on Thursday go as badly for the government as expected."
Pugh added: "For the economy, the prospect of a leadership challenge is yet another source of uncertainty for businesses and households that could prompt them to put off investment and spending. What's more, financial markets would likely respond by pushing gilt yields higher, as any successor is likely to be more spendthrift than Starmer and Reeves, raising borrowing costs across the economy. The risk is that a messy leadership contest, which causes another round of speculation about tax hikes, potentially followed by another budget would compound the drag on growth from higher energy prices and tip the economy further into stagnation."
National Debt Context
The total national debt currently stands at approximately £2.9 trillion, nearly equivalent to the UK's annual gross domestic product (GDP). Higher gilt yields increase the cost of servicing this debt. The Office for Budget Responsibility estimated that debt servicing costs would reach £111 billion in the last financial year.
