Why the soaring cost of government borrowing matters for everyone

Published

1 year ago

October 23, 2023

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Except on rare occasions – last year’s post-Liz Truss mini-budget episode being one of them – the bond market rarely garners as much attention as other financial sectors.

Yet these markets, where companies and governments come to borrow, are the foundations for the global economy.

In particular, the value of government bonds – and hence their imputed interest rates – have an enormous bearing on all our lives. Higher bond yields, as these interest rates are called, imply that we will all be paying more interest on that debt for years to come.

So the fact that these interest rates are shooting up rapidly around the world in recent weeks is no trivial matter. On Monday morning, the yield on US 10-year debt (typically seen as a benchmark for this market) broke through the 5% mark.

The UK’s own 10-year government debt is, at 4.7%, now above the highs it hit following last autumn’s mini-budget.

The 30-year UK government bond yield just hit the highest level since 1998. This is big stuff – and indeed the degree of yo-yoing in recent weeks has been unprecedented.

Something is clearly going on in these markets, but what?

This is where things get a little murkier, because it turns out there is no single, definitive explanation for these fluctuations. That comes back to a broader point, which is that the price of a given country’s debt is telling you lots of things at the same time.

It could be telling you about future expectations for where central bank interest rates are heading in future. At one and the same time, it could be signalling how much demand there is in capital markets for a given country’s debt. It could equally be caused by supply: if a government is issuing lots of debt, you might reasonably expect people to ask for higher interest rates to lend them that money.

And the explanation for the recent rise in bond yields could well be all of the above.

A lot of debt

It’s worth saying, before we go into it, that most of this shift seems to be centred on the US economy – but any rise in Treasury yields (those US government bonds are typically referred to as “Treasuries”) has a direct impact on the rest of the world. So it matters for everyone.

Anyway, let’s take the central bank thesis first. Up until quite recently, most economists and investors had been assuming that having risen sharply in recent years, official central bank interest rates would be cut quite rapidly next year – that the shape of the future interest rate curve might resemble the Matterhorn, that Swiss mountain which used to be on the side of Toblerone packages until they stopped making the chocolate in Switzerland.

But central banks, including the US Federal Reserve and Bank of England, have been at pains recently to signal that those rates might not be coming down quite so quickly.

In fact, says Bank of England chief economist Huw Pill, the future path for interest rates might look a bit more like Table Mountain – a long, flat plateau of higher rates.

So that’s one part of the explanation. Another is that right now the US government is borrowing enormous amounts of money, partly to finance its Inflation Reduction Act and CHIPS Act, as well as new Biden administration welfare policies.

The combined effect is, according to the Congressional Budget Office, to lift the US national debt up to the highest levels since the aftermath of WWII.

That’s a lot of debt – and while everyone’s known about these plans for some time, it’s possible investors are only now beginning to baulk at the prospect of absorbing all that debt.

Dangerous territory

The final explanation, which is considerably more speculative but also more unsettling, comes back to something else.

You may recall that after Russia invaded Ukraine, Western nations talked about doing what they could to ensure Russia would pay for reconstruction in Ukraine, including potentially seizing Russian assets held in Western nations.

No one is entirely sure how this would work, but at the recent IMF annual meetings in Marrakech, the group of seven leading economies (the US, Japan, Germany, the UK, France, Canada and Italy) agreed to begin working on it.

As I say, no one is entirely sure how this should be done. It might be possible to confiscate some of the interest payments which might otherwise have been due to Russia, earned by Russian assets held in Europe.

But the G7 is also aware that this is dangerous territory, begging questions about the function of international law and the international monetary system.

It also sends a pretty clear message to other countries. If the G7 is content to start seizing Russian assets in their countries then what is to stop them doing likewise with, say, Chinese assets?

Perhaps you see where this is going. At the moment, China is one of the biggest buyers of US government debt, and there is evidence that it is slowing its purchases of US government debt.

Might that be because it’s somewhat spooked by the ongoing efforts to recoup money from Russia? Might Chinese authorities worry that something similar could or would happen to its holdings of US Treasuries if it invaded Taiwan? No one knows for sure, but this is another not altogether implausible explanation for those higher bond yields.

All of which is to say: it’s complicated. But it’s also quite scary. And higher interest rates mean higher debt repayment costs for this country in the coming years.

The ability of this government (or a possible future Labour government) to borrow to finance big projects in future depends on being able to borrow at a reasonable interest rate. And those interest rates are getting considerably higher.

Business

FTSE 100 closes at record high

Published

6 hours ago

January 17, 2025

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The UK’s benchmark stock index has reached another record high.

The FTSE 100 index of most valuable companies on the London Stock Exchange closed at 8,505.69, breaking the record set last May.

It had already broken its intraday high at 8532.58 on Friday afternoon, meaning it reached a high not seen before during trading hours.

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The weakened pound has boosted many of the 100 companies forming the top-flight index.

Why is this happening?

Most are not based in the UK, so a less valuable pound means their sterling-priced shares are cheaper to buy for people using other currencies, typically US dollars.

This makes the shares better value, prompting more to be bought. This greater demand has brought up the prices and the FTSE 100.

The pound has been hovering below $1.22 for much of Friday. It’s steadily fallen from being worth $1.34 in late September.

Also spurring the new record are market expectations for more interest rate cuts in 2025, something which would make borrowing cheaper and likely kickstart spending.

What is the FTSE 100?

The index is made up of many mining and international oil and gas companies, as well as household name UK banks and supermarkets.

Familiar to a UK audience are lenders such as Barclays, Natwest, HSBC and Lloyds and supermarket chains Tesco, Marks & Spencer and Sainsbury’s.

Other well-known names include Rolls-Royce, Unilever, easyJet, BT Group and Next.

FTSE stands for Financial Times Stock Exchange.

If a company’s share price drops significantly it can slip outside of the FTSE 100 and into the larger and more UK-based FTSE 250 index.

The inverse works for the FTSE 250 companies, the 101st to 250th most valuable firms on the London Stock Exchange. If their share price rises significantly they could move into the FTSE 100.

A good close for markets

It’s a good end of the week for markets, entirely reversing the rise in borrowing costs that plagued Chancellor Rachel Reeves for the past ten days.

Fears of long-lasting high borrowing costs drove speculation she would have to cut spending to meet self-imposed fiscal rules to balance the budget and bring down debt by 2030.

Long-term government borrowing had reached a high not seen since 1998 while the benchmark 10-year cost of government borrowing, as measured by 10-year gilt yields, was at levels last seen around the 2008 financial crisis.

The gilt yield is effectively the interest rate investors demand to lend money to the UK government.

Only the pound has yet to recover the losses incurred during the market turbulence. Without that dropped price, however, the FTSE 100 record may not have happened.

Also acting to reduce sterling value is the chance of more interest rates. Currencies tend to weaken when interest rates are cut.

Business

Trump tariff threat prompts IMF warning ahead of inauguration

Published

9 hours ago

January 17, 2025

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Trump tariff threat prompts IMF warning ahead of inauguration

The International Monetary Fund (IMF) has warned against the prospects of a renewed US-led trade war, just days before Donald Trump prepares to begin his second term in the White House.

The world’s lender of last resort used the latest update to its World Economic Outlook (WEO) to lay out a series of consequences for the global outlook in the event Mr Trump carries out his threat to impose tariffs on all imports into the United States.

Canada, Mexico, and China have been singled out for steeper tariffs that could be announced within hours of Monday’s inauguration.

Mr Trump has been clear he plans to pick up where he left off in 2021 by taxing goods coming into the country, making them more expensive, in a bid to protect US industry and jobs.

He has denied reports that a plan for universal tariffs is set to be watered down, with bond markets recently reflecting higher domestic inflation risks this year as a result.

While not calling out Mr Trump explicitly, the key passage in the IMF’s report nevertheless cautioned: “An intensification of protectionist policies… in the form of a new wave of tariffs, could exacerbate trade tensions, lower investment, reduce market efficiency, distort trade flows, and again disrupt supply chains.

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“Growth could suffer in both the near and medium term, but at varying degrees across economies.”

In Europe, the EU has reason to be particularly worried about the prospect of tariffs, as the bulk of its trade with the US is in goods.

The majority of the UK’s exports are in services rather than physical products.

The IMF’s report also suggested that the US would likely suffer the least in the event that a new wave of tariffs was enacted due to underlying strengths in the world’s largest economy.

The WEO contained a small upgrade to the UK growth forecast for 2025.

It saw output growth of 1.6% this year – an increase on the 1.5% figure it predicted in October.

Economists see public sector investment by the Labour government providing a boost to growth but a more uncertain path for contributions from the private sector given the budget’s £25bn tax raid on businesses.

Business lobby groups have widely warned of a hit to investment, pay and jobs from April as a result, while major employers, such as retailers, have been most explicit on raising prices to recover some of the hit.

Chancellor Rachel Reeves said of the IMF’s update: “The UK is forecast to be the fastest growing major European economy over the next two years and the only G7 economy, apart from the US, to have its growth forecast upgraded for this year.

“I will go further and faster in my mission for growth through intelligent investment and relentless reform, and deliver on our promise to improve living standards in every part of the UK through the Plan for Change.”

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Run of bad economic data brings end to market turbulence and interest rate benefits as three Bank cuts expected for 2025

Published

9 hours ago

January 17, 2025

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Run of bad economic data brings end to market turbulence and interest rate benefits as three Bank cuts expected for 2025

A week of news showing the UK economy is slowing has ironically yielded a positive for mortgage holders and the broader economy itself – borrowing is now expected to become cheaper faster this year.

Traders are now pricing in three interest rate cuts in 2025, according to data from the London Stock Exchange Group.

Earlier this week just two cuts were anticipated. But this changed with the release of new official statistics on contracting retail sales in the crucial Christmas trading month of December.

It firmed up the picture of a slowing economy as shrunken retail sales raise the risk of a small GDP fall during the quarter.

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That would mean six months of no economic growth in the second half of 2024, a period that coincides with the tenure of the Labour government, despite its number one priority being economic growth.

Clearer signs of a slackening economy mean an expectation the Bank of England will bring the borrowing cost down by reducing interest rates by 0.25 percentage points at three of their eight meetings in 2025.

If expectations prove correct by the end of the year the interest rate will be 4%, down from the current 4.75%. Those cuts are forecast to come at the June and September meetings of the Bank’s interest rate-setting Monetary Policy Committee (MPC).

The benefits, however, will not take a year to kick in. Interest rate expectations can filter down to mortgage products on offer.

Despite the Bank of England bringing down the interest rate in November to below 5% the typical mortgage rate on offer for a two-year deal has been around 5.5% since December while the five-year hovered at about 5.3%, according to financial information company Moneyfacts.

The market has come more in line with statements from one of the Bank’s rate-setting MPC members. Professor Alan Taylor on Wednesday made the case for four cuts in 2025.

His comments came after news of lower-than-expected inflation but before GDP data – the standard measure of an economy’s value and everything it produces – came in below forecasts after two months of contraction.

News of more cuts has boosted markets.

The cost of government borrowing came down, ending a bad run for Chancellor Rachel Reeves and the government.

State borrowing costs had risen to decade-long highs putting their handling of the economy under the microscope.

The prospect of more interest rate cuts also contributed to the benchmark UK stock index the FTSE 100 reaching a new intraday high, meaning a level never before seen during trading hours. A depressed pound below $1.22, also contributed to this rise.

Similarly, falling US government borrowing has reduced UK borrowing costs after US inflation figures came in as anticipated.