UK Borrowing Costs Jump Again on Fears Iran Conflict Will Curb Growth
Investors fear rising oil and gas costs will stoke inflation and delay cuts in interest rates, as UK borrowing costs jumped for a second day on Tuesday. The potentially damaging effects of the Iran conflict have spooked investors, who are concerned that growth will stall across major industrial economies.
Market Turmoil and Energy Price Surges
Analysts said higher energy costs are likely to lead to price rises, forcing central banks to delay expected cuts in interest rates until later this year. Brent crude passed $83 a barrel on Tuesday, up from about $60 in December, driven by fears over Middle East instability, including a fire at the UAE's Fujairah oil terminal after a drone attack was intercepted.
The government had hoped that last month's decline in inflation to 3% and a faster fall in Whitehall's annual spending deficit would further push down the interest on UK debt. However, the better-than-expected borrowing figures trumpeted by Rachel Reeves in her spring forecast speech on Tuesday failed to generate a positive bounce amid growing anxiety over the Middle East crisis.
Impact on Interest Rate Expectations
Since the conflict broke out at the weekend, market bets for Bank of England policymakers to cut interest rates when they next meet on 19 March have fallen from 80% to just 30%. Government borrowing costs have been on the rise, with yields on two-year gilts – effectively the interest rate – jumping as much as 16 basis points to 3.8% on Tuesday, although they later eased back to settle at nearer 10 points up.
David Aikman, director of the National Institute of Economic and Social Research, said: "The UK's improved borrowing position announced in today's spring statement has been overshadowed by the Middle East crisis. If the crisis persists, higher energy prices will feed through to inflation, increasing borrowing costs further, putting serious pressure on the budget outlook."
Expert Insights and Economic Forecasts
Kathleen Brooks, a research director at the currency trader XTB, said: "There is no denying that the spring statement was unfortunately timed. UK bond yields are soaring on Tuesday, and this time it is not Rachel Reeves's fault. UK two- and 10-year gilt yields are higher as the bond market prices in the worst-case scenario of a prolonged war in the Middle East and an energy-price inflation shock."
Paul Dales, the chief UK economist at Capital Economics, said the Bank of England was probably more sensitive to the upside risk to inflation from the conflict than other central banks. Last month, the Bank's monetary policy committee held rates at 3.75% after a majority of policymakers said they wanted to wait and see how quickly inflation would fall before making further reductions.
In its spring forecast assessment of the outlook for borrowing costs over the next five years, the Office for Budget Responsibility (OBR) said they had fallen significantly, benefiting the public finances. However, the latest increases in bond yields reversed gains made since last month when the OBR carried out its assessment.
David Miles, the forecaster's chief economist, said predictions that inflation would fall to target levels early this year had become "more uncertain" after jumps in oil and gas prices linked to recent attacks in the Middle East. He added: "I think what will happen to inflation is particularly uncertain in the past few days. As I mentioned earlier and we all know, there have been very large increases in gas prices and oil prices. Our central expectation had been that inflation would fall back towards the Bank of England's 2% target early this year and will be around that level at the end of the year. There must be more uncertainty around that right now."
Future Government Bond Issuance
Britain plans to issue £252.1 billion of government bonds in the 2026-27 financial year, according to the UK Debt Management Office. This total compares with primary dealers' median forecast of £245 billion of gilt issuance in a Reuters poll, down from £303.7 billion of issuance in 2025-26, reflecting ongoing adjustments in response to economic pressures.
