What’s going on in the markets and should we be worried?
The chancellor is under pressure because financial market moves have pushed up the cost of government borrowing, putting Rachel Reeves’ economic plans in peril.
So what’s going on, and should we be worried?
What is a bond?
UK Treasury bonds, known as gilts because they used to literally have gold edges, are the mechanism by which the state borrows money from investors.
They pay a fixed annual return, known as a coupon, to the lender over a fixed period – five, 10 and 30 years are common durations – and are traded on international markets, which means their value changes even as the return remains fixed.
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That means their true interest rate is measured by the ‘yield’, which is calculated by dividing the annual return by the current price. So when bond prices fall, the yield – the effective interest rate – goes up.
And for the last three months, markets have been selling off UK bonds, pushing borrowing costs higher. This week the yield on 30-year gilts reached its highest level since 1998 at 5.37%, and 10-year gilts briefly hit a level last seen after the financial crisis, sparking jitters in markets and in Westminster.
Why are investors selling UK bonds?
Bond markets are influenced by many factors but the primary domestic pressure is the prospect of persistent inflation, with interest rates staying high for longer as a consequence.
Higher inflation reduces the purchasing power of the coupon, and higher interest rates make the bond less competitive because investors can now buy bonds paying a higher rate. Both of which apply in the UK.
Inflation remains higher than the Bank of England‘s 2% target and many large companies are warning of further price rises as tax and wage rises bite in the spring.
As a result, the Bank is now expected to cut rates only twice this year, as opposed to the four reductions priced in by markets as recently as November.
Nor is there much optimism that the economic growth promised by the chancellor will save the day in the short term, with business groups warning investment will be tempered by taxes.
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Sky News’ Ed Conway on the impact of increased long-term borrowing costs as they hit their highest level in the UK since 1998
Is the UK alone?
No. Bond markets are international and in recent months the primary influence has been rising borrowing costs in the US, triggered by Donald Trump’s re-election and the assumption that tariffs and other policies will be inflationary.
The UK is not immune from those forces, and other European nations including Germany and France, facing their own political gyrations, have seen costs rise too. (The US influence could yet increase if strong labour market figures on Friday reinforce the sense that rates will remain high).
But there are specific domestic factors, particularly the prospect of stagflation. The UK is also more reliant on overseas investors than other G7 nations, which means the markets really matter.
Why does it matter to Reeves?
The cost of borrowing affects not just the issuance of new debt but the price of maintaining existing loans, and it matters because these higher costs could erode the “headroom” Ms Reeves left herself in her budget.
Headroom is a measure of how much slack she has against her self-imposed fiscal rule, itself intended to reassure markets that the UK is a stable location for investment, to fund day-to-day spending entirely from tax revenue by 2029-30.
At the budget, she had just £9.9bn of headroom and some analysts estimate market pressure has eroded all but £1bn of that.
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At the end of March the Office for Budget Responsibility will provide an update on the fiscal position and market conditions could change before then, but if they don’t then Ms Reeves may have to rewrite her plans.
The Treasury this week described the fiscal rules as “non-negotiable”, which leaves a choice between raising taxes or, more likely, cutting costs to make the numbers add up.
Why does it matter to the rest of us?
Persistently higher rates could push up consumer debt costs, increasing the burden of mortgages and other loans. Beyond that, the state of the economy matters to all of us.
The underlying challenges – persistent inflation, stagnant growth, worse productivity, ailing public services – are fundamental, and Labour has promised to address them.
Investment in infrastructure and new industries, spurred by planning and financial market reform, are all promised as medium-term solutions to the structural challenges. But politics, like financial markets, is a short-term business, and Ms Reeves could do with some relief, starting with helpful inflation and growth figures due next week.
The energy regulator has confirmed plans for a massive upgrade to the UK’s energy grids, adding £108 to customer bills by 2031.
Ofgem said on Thursday that the £28bn investment over the next five years would bolster resilience in the transition to a renewable energy future and that much of the bill would be offset by increased efficiency.
It pointed to estimated savings for households of around £80 because of the planned investment in gas and power infrastructure, leaving a net additional contribution of £28.
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Ofgem said the £28bn sum formed part of an estimated £90bn to be invested in the energy networks by 2031, with “adaptive” funding arrangements helping to shield customers from volatility in the market.
Most of the funding announced on Thursday will go towards maintaining gas networks, which will remain a key source of energy as green power capacity is built up further.
“Investing now to maintain world-class resilience and expand grid capacity is the most cost-effective way to harness clean power, support economic growth and protect the country from gas price shocks like the one seen in 2022”, Ofgem said.
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What’s driving energy prices higher?
Then, Russia’s invasion of Ukraine and Europe’s refusal to buy Russian gas in response, meant that energy bills hit unprecedented levels and gave birth to the wider cost-of-living crisis as higher energy costs were passed on across the economy.
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Ofgem made its announcement as costs of government energy policy and other upgrades make the biggest upwards contributions to household bills. However, the budget moved to take away some costs from April next year.
Ofgem boss Jonathan Brearley said: “The funding announced today will keep Britain’s energy network among the safest, most secure and resilient in the world. The investment will support the transition to new forms of energy and support new industrial customers to help drive economic growth and insulate us from volatile gas prices.
“But this is not investment at any price. Every pound must deliver value for consumers. Ofgem will hold network companies accountable for delivering on time and on budget, and we make no apologies for the efficiency challenge we’re setting as the industry scales up investment.
“We’ve built strong consumer protections into these contracts, meaning funds will only be released when needed and clawed back if not used. Households and businesses must get value for money, and we will ensure they do.”
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‘It’s either keep warm or eat’
A Department for Energy Security and Net Zero spokesperson said: “This government is taking action to bring down energy bills for families, with the budget taking an average £150 of costs off bills in April, and expanding our £150 Warm Home Discount to over six million families.
“Upgrading our gas and electricity networks after years of underinvestment is essential to keep the lights on and ensure energy security for our country. Without these plans, which were first set out under the previous government, costs would spiral and our security would be compromised.
“The only way to bring down bills for good and get off the fossil fuel rollercoaster is with this government’s mission to deliver clean homegrown that we control.”
The UK government is being urged to take even stronger action to tackle the ongoing crisis of families unable to afford baby formula milk.
The prime minister backed limited reforms to the market to help parents save money but will not yet support more radical changes.
Sir Keir Starmer confirmed support for better public health messaging to inform parents that cheaper brands are nutritionally equivalent when compared with the most expensive.
A ban on spending store loyalty points on baby formula will also be lifted.
They were among recommendations made by the Competition and Markets Authority which investigated the baby formula industry and described the price rises in recent years as unjustifiable.
A newborn. File Pic: iStock
In the House of Commons the prime minister said: “For too long parents have been pushed into spending more on infant formula.
“They were told they’re paying for better quality and left hundreds of pounds out of pocket.
“I can announce today that we’re changing that. We will take action to give parents and carers the confidence to access infant formula at more affordable prices, with clearer guidance for retailers on helping new parents use loyalty points and vouchers together.”
It comes two-and-a-half years after a Sky News investigation revealed the extreme measures families were taking to feed their babies.
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Parents described how they had resorted to stealing to feed their infants, some were watering down formula milk or substituting it for condensed milk.
The British Pregnancy Advisory Service described the situation in 2023 as a “national scandal”.
Campaigners told Sky News the UK government needed to go further to address the crisis.
Co-founder of Feed UK Erin Williams told Sky News: “It is progress, they promised to look at this enormous nationwide problem and they have.
“At the moment women are still not routinely getting important information before giving birth – this should be given proactively to everybody and that will be a big win.
“The prime minister though needs to be tougher on the baby formula companies.
“Their marketing claims, their unjustified pricing – it’s stacked against families who just need to feed their babies safely.”
The UK government stopped short of accepting all of the recommendations made by the CMA.
More radical ideas such as a price cap on baby formula are not being considered.
Charities have also told Sky News the situations some families find themselves in have not eased.
Founder of the Hartlepool Baby Bank, Emilie De Bruijn, told Sky News the demand they see from desperate families is “constant and unmanageable”.
She said: “Parents are really feeling the pinch right now, and demands on baby banks are rising and it can feel quite relentless.
“We are pleased to see the extension of the National Breastfeeding Helpline alongside measures such as allowing parents to use points and vouchers.
“It is important that parents are supported to feed their children in whatever way they want and we hope that steps will continue to be taken to reduce the cost of formula and increase understanding that all brands are nutritionally the same.”
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