Why the soaring cost of government borrowing matters for everyone

Published

2 years 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.

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Interest rate cut to 4.25% by Bank of England

Published

20 hours ago

May 8, 2025

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Interest rate cut to 4.25% by Bank of England

The Bank of England has cut interest rates from 4.5% to 4.25%, citing Donald Trump’s trade war as one of the key reasons for the reduction in borrowing costs.

In a decision taken shortly before the official confirmation of a trade deal between Britain and the United States, the Bank’s monetary policy committee (MPC) voted to reduce borrowing costs in the UK, saying the economy would be slightly weaker and inflation lower in part as a result of higher tariffs.

However, it stopped short of predicting that the trade war would trigger a recession.

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Further rate cuts are expected in the coming months, though there remains some uncertainty about how fast and how far the MPC will cut – since it was split three ways on this latest vote.

Two members of the nine-person MPC voted to reduce rates by even more today, taking them down to 4%. But another two on the committee voted not to cut them at all, leaving them instead at 4.5%.

In the event, five members voted for the quarter point cut – enough to tip the balance – with the accompanying minutes saying that while “the current impact of the global trade news should not be overstated, the news was sufficient for those members to judge that a reduction in Bank Rare was warranted.”

Even so, the Bank’s analysis suggests that while higher tariffs were likely to depress global and UK economic growth, and help push down inflation, the impact would be relatively minor, with growth only 0.3% lower and inflation only 0.2% lower.

Governor, Andrew Bailey, said: “Inflationary pressures have continued to ease, so we’ve been able to cut rates again today.

“The past few weeks have shown how unpredictable the global economy can be. That’s why we need to stick to a gradual and careful approach to further rate cuts. Ensuring low and stable inflation is our top priority.”

The Bank raised its forecast for UK economic growth this year from 0.75% to 1%, but said that was primarily because of unexpectedly strong output in the first quarter.

In fact, underlying economic growth remains weak at just 0.1% a quarter.

It said that while inflation was expected to rise further in the coming months, peaking at 3.5% in the third quarter, it would drop down thereafter, settling at just below 2% towards the end of next year.

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Trump set to announce US will agree trade deal with UK, Sky News understands

Published

1 day ago

May 8, 2025

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Trump set to announce US will agree trade deal with UK, Sky News understands

Donald Trump is set to announce that America will agree a trade deal with the UK, Sky News understands.

A government source has told Sky’s deputy political editor Sam Coates that initial reports about the agreement in The New York Times are correct.

Coates says he understands a “heads of terms” agreement, essentially a preliminary arrangement, has been agreed which is a “substantive” step towards a full deal.

Three sources familiar with the reported plans had earlier told the New York Times that the US president will announce on Thursday that the UK and US will agree a trade deal.

Shortly after the report emerged the value of the British pound rose by 0.4% against the US dollar.

Mr Trump had earlier teased that he would be announcing a major trade deal in the Oval Office at 10am local time (3pm UK time) on Thursday without specifying which country it had been agreed with.

Writing in a post on his Truth Social platform on Wednesday, he said the news conference announcing the deal would be held with “representatives of a big, and highly respected, country”.

He did not offer more details but said the announcement would be the “first of many”.

A White House spokesperson has declined to comment on the New York Times report.

Senior Trump officials have been engaging in a flurry of meetings with trading partners since the US president announced his “liberation day” tariffs on both the US’ geopolitical rivals and allies on 2 April.

Mr Trump imposed a 10% tariff on most countries including the UK during the announcement, along with higher “reciprocal” tariff rates for many trading partners.

However those reciprocal tariffs were later suspended for 90 days.

Britain was not among the countries hit with the higher reciprocal tariffs because it imports more from the US than it exports there.

However, the UK was still impacted by a 25% tariff on all cars and all steel and aluminium imports to the US.

A UK official said on Tuesday that the two countries had made good progress on a trade deal that would likely include lower tariff quotas on steel and cars.

Mr Trump said the same day that he and top administration officials would review potential trade deals with other countries over the next two weeks to decide which ones to accept.

Last week he said that he has “potential” trade deals with India, South Korea and Japan.

Asked on Sky News’ Breakfast programme about the UK-EU summit on 19 May and how Mr Starmer would balance relationships with the US and EU, Coates said: “I think it is politically helpful for Keir Starmer to have got the heads of terms, the kind of main points of a US-UK trade deal, nailed down before we see what we have negotiated with the EU — or, more importantly, Donald Trump sees what we have negotiated with the EU.”

Coates said there was “always a danger” that if it happened the other way around, Mr Trump would “take umbrage” at negotiations with the EU and “downgrade, alter or put us further back in the queue” when it came to a UK-US trade deal.

US and Chinese officials to discuss trade war

It comes as the US and China have been engaged in an escalating trade war since Mr Trump took office in January.

The Trump administration has raised tariffs on Chinese goods to 145% while Beijing has responded with levies of 125% in recent weeks.

US Treasury secretary Scott Bessent and US trade representative Jamieson Greer are set to meet their Chinese counterparts in Switzerland this week to discuss the trade war.

China has made the de-escalation of the tariffs a requirement for trade negotiations, which the meetings are supposed to help establish.

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UK-India trade deal: Is Farage right to call out ‘big tax exemption’?

Published

2 days ago

May 7, 2025

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UK-India trade deal: Is Farage right to call out 'big tax exemption'?

Britain’s trade deal with India has created a pocket of controversy on taxation.

Under the agreement, Indian workers who have been seconded to Britain temporarily will not have to pay National Insurance (NI) contributions in the UK. Instead, they will continue to pay the Indian exchequer.

The same applies to British workers in India. It avoids workers from being taxed twice for a full suite of benefits they will not receive, such as the state pension.

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Politicians of all stripes have leapt to judgement.

Nigel Farage has described it as a “big tax exemption” for Indian workers. He said it was “impossible to say how many will come,” with the Reform Party warning of “more mass immigration, more pressure on the NHS, more pressure on housing.”

But, is this deal really undercutting British workers or is it simply creating a level playing field?

Be wary of any hasty conclusions. In the absence of an impact assessment from the government, it is difficult to be precise about any of this. However, at first glance, it is unlikely that some of Reform’s worst fears will play out.

Firstly, avoiding double taxation is not the same thing as a “tax break.’ This type of agreement, known as a double contribution convention, is not new.

Britain has similar arrangements with other countries and blocs, including the US, EU, Canada and Japan.

It’s based on the principle that workers shouldn’t be paying twice for social security taxes that they will not benefit from.

Indian workers and businesses will still have to pay the equivalent tax in India, as well as sponsorship fees and the NHS surcharge.

Crucially, the deal only applies to workers being sent over by Indian companies on a temporary basis.

Those workers are on Indian payroll. It does not apply to Indian workers more generally. That means businesses in the UK can’t (and won’t) suddenly be replacing all their workers with Indians.

The conditions for a company to send over a secondee on a work visa are restrictive. It means it’s unlikely that these workers will be replacing British workers.

However, It does mean that the exchequer will not capture the extra national insurance tax from those who come over on this route.

The government has not shared its impact assessment for how many extra Indians they expect to come over on this route, how much NI they will escape, or how much this will be offset by extra income tax from those Indians. The net financial position is therefore murky.