Key Takeaways
- The UK’s "premium" on borrowing costs may be decreasing as markets gain confidence in the government’s fiscal plans
- The autumn budget announcement to increase financial headroom by 2030 has begun to assure bond markets about Labour’s fiscal approach
- UK gilt yields have been higher than major peers, costing taxpayers up to £7bn a year
- The problem lies in the UK’s "credibility problem" in keeping to its fiscal policies, not in the fundamentals of its economy
- The Bank of England’s sale of government bonds at a record pace is adding unnecessary pressure to the gilt market and should be paused
Introduction to the UK’s Borrowing Costs
The United Kingdom’s "premium" on borrowing costs, which is the difference in the cost of borrowing compared to its international peers, may be coming to an end. This is according to the Institute for Public Policy Research (IPPR), a left-leaning thinktank, which suggests that markets are growing more confident about the government’s plans. The chancellor, Rachel Reeves, announced in the autumn budget that she would be more than doubling the UK’s financial headroom by 2030, from £9.9bn to £22bn. This announcement has begun to assure bond markets about Labour’s fiscal approach, which has been a major factor in the UK’s higher borrowing costs.
The UK’s Credibility Problem
The UK’s gilt yields, which is the return paid on government debt, have been increasing around the world in recent years due to higher inflation, rising interest rates, and countries running bigger deficits. However, the UK’s yields have been higher than its peers, including the US and the eurozone, largely because the economy suffers from a "credibility problem" over whether its fiscal policies will be achieved. The IPPR states that the UK yields have risen by 0.4 to 0.8 percentage points more than major peers since Labour won the 2024 election, costing taxpayers up to £7bn a year. This is despite the fundamentals of the UK’s economy being stronger than countries with lower borrowing costs, with a debt-to-GDP ratio of 101% compared to 122% in the US and 237% in Japan.
The Cause of the Credibility Problem
The problem lies in the UK’s history of not keeping to its fiscal policies. The mini-budget in 2022 under the Liz Truss administration "showed how quickly a UK government could bypass the fiscal framework", according to the IPPR. Successive chancellors have "repeatedly changed, missed or redefined their own fiscal rules" or changed themselves, with seven different chancellors from 2016 up to the 2024 election. This has led to a "lack of trust in stated fiscal policy" as actions have spoken louder than words. The IPPR suggests that this lack of trust has resulted in the UK’s higher borrowing costs, despite its stronger economic fundamentals.
The Autumn Budget and Its Impact
However, the autumn budget has prompted the UK premium against the eurozone to almost halve. William Ellis, a senior economist at IPPR, stated that "the premium on UK borrowing costs appears to be easing, showing that markets are responding to growing confidence in the government’s fiscal approach". Sticking to its fiscal plans could save the exchequer billions and free up fiscal space in the future. This suggests that the government’s announcement to increase financial headroom by 2030 has begun to reassure bond markets about Labour’s fiscal approach.
The Role of the Bank of England
The IPPR also suggests that another way to lower borrowing costs would be for the Bank of England to pause its sale of government bonds after "selling them at a record pace". Carsten Jung, the associate director for economic policy at IPPR, stated that "the Bank of England needs to pull its weight. Actively selling government bonds is adding unnecessary pressure to the gilt market. It should stop – just as every other major central bank has". This would help to reduce the pressure on the gilt market and lower borrowing costs for the UK.
Conclusion
In conclusion, the UK’s "premium" on borrowing costs may be decreasing as markets gain confidence in the government’s fiscal plans. The autumn budget announcement to increase financial headroom by 2030 has begun to assure bond markets about Labour’s fiscal approach. However, the UK’s credibility problem in keeping to its fiscal policies remains a major factor in its higher borrowing costs. The Bank of England’s sale of government bonds at a record pace is also adding unnecessary pressure to the gilt market and should be paused. By addressing these issues, the UK can reduce its borrowing costs and free up fiscal space in the future.
