City workers pass the Bank of England, centre, in London. Photographer: Chris Ratcliffe\/Bloomberg <\/p>\n
(Bloomberg) — The yield on long-dated UK bonds rose to the highest since 1998 and the pound fell, pressuring Prime Minister Keir Starmer\u2019s government to regain the confidence of investors who remain concerned over the fiscal outlook.<\/p>\n
Yields on 30-year gilts jumped eight basis points to 5.72% and the pound weakened as much as 1.3% against the dollar, lagging all other major currencies. The FTSE 100 Index retreated 0.6%.<\/p>\n<\/p>\n
Most Read from Bloomberg<\/p>\n
The UK\u2019s benchmark 10-year yield is the highest among Group-of-Seven nations and rising debt costs threaten to worsen a perilous fiscal backdrop facing Chancellor of the Exchequer Rachel Reeves ahead of her autumn budget.<\/p>\n
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She\u2019s scrambling to find savings or raise taxes to plug a \u00a335 billion ($47 billion) budget hole, according to Bloomberg Economics estimates. That may prove politically difficult, given the government had to U-turn on welfare reforms after a rebellion among lawmakers.<\/p>\n
\u201cThe situation in the UK is quite dangerous at the moment because of the return of the bond vigilantes,\u201d said Ludovic Subran, Allianz chief investment officer. \u201cWhat is striking is that it took so long to factor in the return of inflation into gilts. Forward guidance on the fiscal side will be needed.\u201d<\/p>\n
WATCH: The UK is in a \u201cdangerous\u201d situation, Allianz CIO Ludovic Subran says.Source: Bloomberg <\/p>\n
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The selloff in the 30-year bond in particular reflects waning demand for longer debt from traditional buyers such as defined-benefit pension funds, as well as concerns over structurally higher inflation. The UK\u2019s Debt Management Office has already slashed sales of such securities to a record low, and some are calling for it to go even further.<\/p>\n
Meanwhile, the government offered a slightly bigger discount than investors had been expecting on a syndicated sale of a 2035 bond on Tuesday, helping secure record demand of \u00a314 billion, according to Megum Muhic, a strategist at RBC. The yield on 10-year debt in the secondary market was up six basis points at 4.81%, trading at the highest levels since January.<\/p>\n
Tax Test<\/p>\n
Economists are predicting the UK will soon need to raise taxes to keep on the right side of the government\u2019s self-imposed fiscal rules. Borrowing costs are a key determinant of the UK\u2019s fiscal arithmetic \u2014 potentially putting Reeves and Starmer at the mercy of bond yields.<\/p>\n
Story Continues <\/p>\n
Explainer: UK Tax Hikes Loom as Reeves Faces Budget Dilemma<\/p>\n
Starmer announced a raft of changes to his Downing Street team on Monday in a reset aimed at securing more influence over economic policy. The main fiscal rule is that day-to-day government spending should be covered by tax revenues within five years, so that borrowing is only for investment.<\/p>\n
\u201cThe moves Starmer made yesterday \u2014 bringing some different people into Number 10 \u2014 is kind of making people question who\u2019s actually in charge of the fiscal side,\u201d David Zahn, head of European fixed income at the firm, said in a Bloomberg TV interview. He repeated his call for the 30-year yield to surpass 6%.<\/p>\n
WATCH: Franklin Templeton\u2019s David Zahn expects the yield on 30-year UK bonds to climb above 6% by the end of the year.Source: Bloomberg <\/p>\n
\u201cI think they\u2019re going to continue to try and just plug along and not really address the problems,\u201d Zahn said. \u201cBut if the yields get too high, eventually they will have to do something much more substantial which will include spending cuts.\u201d<\/p>\n
Starmer\u2019s spokesman, Dave Pares, declined to comment on \u201cspecific market movements\u201d when asked on Tuesday, while stressing that \u201cour ironclad commitment to our robust fiscal rules remains.\u201d<\/p>\n
Pound Drop<\/p>\n
The pound also came under pressure as gilt trading opened. Betting in the options market points to the bleakest month-ahead outlook for sterling since July against the dollar.<\/p>\n
\u201cThe moves reflect a broad concern about the fiscal outlook in the developed world,\u201d said Valentin Marinov, head of G10 FX strategy at Credit Agricole. \u201cThe pound is once again seen as the pressure valve for wary investors.\u201d<\/p>\n
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The rise in borrowing costs has invited comparisons to the market meltdown under former Prime Minister Liz Truss.<\/p>\n
The UK risks a \u201cStarmer Moment\u201d similar to the fallout from Truss\u2019s mini-budget three years ago if the government fails to restore faith in the nation\u2019s public finances, Eurizon SLJ Capital chief executive Stephen Jen and Joana Freire wrote on Friday.<\/p>\n
To be sure, the current sell-off is very different in nature.<\/p>\n
The 2022 rout saw forced selling that drove the 30-year yield up as much as 50 basis points in one session, compared with a gradual grind upwards in recent weeks.<\/p>\n
While the moves aren\u2019t limited to UK bonds, they have been at the epicenter of the global slide in long-maturity debt.<\/p>\n
The rate on 30-year gilts has risen more than 100 basis points over the last 12 months, compared with around 80 basis points for comparable US Treasuries and German bonds.<\/p>\n
\u201cTax rises are inevitable, but we are reaching a stage where further tax rises could become counterproductive,\u201d said Mohit Kumar, chief European strategist at Jefferies International. \u201cWe remain negative on the UK long end and continue to favour steepeners along the curve.\u201d<\/p>\n
–With assistance from James Hirai, Naomi Tajitsu, Vassilis Karamanis, Tom Rees and Alex Morales.<\/p>\n
(Updates prices, adds details on bond syndication.)<\/p>\n
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