British government borrowing costs have risen sharply, with 10-year gilt yields reaching highs not seen since 2008 as a combination of political uncertainty and inflation risk makes UK debt less attractive than sovereign bonds in other major advanced economies.
On Tuesday, 10-year yields - which influence the government's cost of future borrowing - hit 5.13% at their peak. Many investors describe a significant amount of apprehension already priced into gilts.
"There’s a lot of fear in the price with gilts," said Gordon Shannon, partner at TwentyFour, which manages 23.5 billion pounds of fixed income assets. Shannon pointed to the likely approach of most potential challengers to Prime Minister Keir Starmer as a source of that fear. Starmer, who entered office in July 2024 with a substantial parliamentary majority, now faces intense pressure that market participants say has translated into higher yields.
According to Shannon, most of the prospective successors to Starmer would be inclined to borrow more, with the possible exception of Health Minister Wes Streeting. He used Greater Manchester Mayor Andy Burnham as an example, noting that Burnham - who would first need to be re-elected to parliament to succeed Starmer - might increase borrowing by an additional 50 billion pounds over five years. That hypothetical extra borrowing would be roughly a 12% rise relative to current borrowing plans, Shannon added, on the assumption that defence spending was exempted from existing finance constraints as Burnham has suggested.
Lingering memories of the 2022 market shock
Market recollection of the policy turmoil during Liz Truss' brief premiership still weighs on the international appeal of gilts. Truss' attempt to implement sharp tax cuts led long-dated gilt prices to fall, a move that prompted the Bank of England to intervene to stop a fire sale by pension funds amid what some described as 'bond vigilantes' circling the market.
Kevin Thozet, a member of the investment committee at Carmignac, said investors had applied what he called a "so-called moron premium" in the aftermath of the market crisis triggered by Truss' mini-budget, and warned that this could be the kind of environment the market is moving toward again.
Despite that, Shannon expressed skepticism that the market would see a repeat of such a sudden selloff. He argued that British politicians now appreciate the need to announce borrowing plans in advance and be ready to scale back if markets react negatively.
Yield comparisons and recent trajectory
UK 10-year gilt yields of 5.12% were cited in comparisons with other major sovereign benchmarks - notably 4.45% in the United States, where economic growth is perceived as stronger, and 3.10% in Germany, which is generally seen as more fiscally disciplined. Since the start of the year, UK 10-year yields have climbed by 0.64 percentage points, a rise that is more than double the increase recorded by 10-year bond yields in the U.S. and Germany over the same period.
Technically, increases in gilt yields affect the government's cost on newly issued debt, so the impact on public finances is not immediate. However, the Office for Budget Responsibility's calculations underscore the longer-term fiscal sensitivity: every percentage point rise in yields is estimated to add around 15 billion pounds a year in debt interest costs by 2030. That is a significant figure against the government's stated objective of achieving a balanced current budget by 2029/30, given that the flexibility remaining to meet that goal is estimated at 24 billion pounds.
Inflation risk and energy prices
Investors and fund managers say elevated inflation risk is a clear component of the premium demanded for gilts. Alexandra Ivanova, a fund manager at Invesco, which holds about $500 billion in bonds, emphasised a checklist approach to what yields should compensate for. "I need to remind investors of 'Finance 101'," she said, listing liquidity risk premium, political risk premium, term premium and inflation risk premium - and adding that, in the case of gilts, each of those elements tends to be higher than elsewhere.
Inflation risk is the most straightforward of those elements to grasp: the U.S.-Israeli war with Iran has pushed oil and natural gas prices roughly 50% higher since the end of February. The UK, which relies on natural gas imports, faces the prospect that higher energy costs could feed into inflation. The Bank of England has warned that inflation could exceed 6% early next year if energy prices rise and then decline slowly. Prior to the conflict, the central bank's forecast had been for inflation to return to its 2% target.
Whereas inflation in the euro zone had returned to target before the conflict, inflation has been more persistent in Britain. The persistence reflects, in part, regulated utility price increases implemented last year and stronger wage growth since the COVID-19 pandemic.
Markets currently price in a rise in the Bank of England's benchmark lending rate to 4.5% by February 2027 from the current level of 3.75%, a shift from earlier expectations of one or two rate cuts prior to the conflict. Many economists, however, remain sceptical of that path given the weak outlook for British growth, which could act as a brake on inflationary pressure.
Structural shifts in gilt demand and market volatility
Beyond politics and inflation, the composition of gilt investors has changed in ways that can amplify price swings and thereby raise yields. For much of the past 20 years, British pension funds and life insurers routinely acquired 30-year gilts to match long-term liabilities. As companies have moved away from defined-benefit pension schemes, that steady source of long-duration demand has diminished.
Nicolas Trindade, senior portfolio manager at BNP Paribas Asset Management, noted that gilt buyers today are more often foreign hedge funds. These investors typically take shorter-term positions and are more sensitive to price moves, increasing the risk of abrupt day-to-day volatility. The potential for large short-term moves, in turn, leads some investors to demand higher yields as compensation for that price risk.
Some market participants also point to the Bank of England's programme of bond sales - currently running at 70 billion pounds a year - as an additional factor that may be exerting upward pressure on gilt yields.
Shannon said he expects the political risk premium to narrow over the medium term, though he described it as more difficult to assess the trajectory of the other premium components.
Market appetite and political stability
For the UK to attract the necessary range of foreign investors, market participants say political continuity matters. "You need various foreign investors to be interested. And turning over prime ministers isn’t what people want to see," the same market source warned, underscoring how leadership questions can translate into tangible market effects.
Currency notation: $1 = 0.7394 pounds.