As the dust settles on a tumultuous week for gilts (UK government bonds) and sterling – a week that has raised serious questions about chancellor Rachel Reeves’s stewardship of the economy – the big question many people will be asking is why investor sentiment has shifted so much against the UK in the past week.

Following on from that is what Ms Reeves should try to do about it.

The first point to make – and indeed it is one the government has been making – is that there has been a broad sell-off in government bonds around the world this week. Yields, which go up as the price of a bond falls, have been rising not only in the case of gilts but also on bonds issued by the likes of the US, Japan, France and Germany.

That reflects the fact that investors are changing their assumptions about the path of inflation this year and, in turn, how central banks like the US Federal Reserve, the European Central Bank and the Bank of England respond.

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Inflation is now expected to be stickier around the world due to a combination of factors, of which by far the biggest is the tariffs the incoming Trump administration is expected to introduce. Those tariffs will push up the price of goods bought by American consumers and, if America’s trading partners respond with tariffs of their own, for consumers elsewhere. US Treasuries have also been under pressure due to expectations that Mr Trump will raise US borrowing sharply.

That said, gilt yields have been rising by more than yields on their international counterparts, reflecting the fact that investors think the UK has specific issues with inflation. The increase in employer’s national insurance contributions (NICs) announced by Ms Reeves in her Halloween budget will be highly inflationary because they will push up the cost of employing people.

The chief executives of some of the UK’s biggest retailers – Lord Wolfson at Next, Ken Murphy at Tesco, Stuart Machin at Marks & Spencer and Simon Roberts at Sainsbury’s – this week repeated their warnings that these higher costs will feed through to higher prices.

Another reason why gilt yields have risen more than those of their international counterparts is the UK’s particular fiscal position and its poor growth prospects.

Yes, other countries have as poor prospects for growth as the UK or as bad a debt situation. The US national debt, for example, is 123% of US GDP while Japan has a debt to GDP ratio of 250%. The UK, with a debt to GDP ratio of just under 99%, doesn’t look so bad by comparison. However, as the market in US Treasuries is the biggest and most liquid in the world and the US dollar is the global reserve currency, investors seldom have hesitation about lending to the US government. Similarly, in the case of Japan, most of its government debt is owned by Japanese savers – encapsulated by the mythical figure of ‘Mrs Watanabe’.

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The UK does not have that luxury and, accordingly, has to rely on what Mark Carney, the former governor of the Bank of England, memorably described in a 2017 speech as “the kindness of strangers” to fund its borrowing (he was talking on that occasion about the UK’s current account deficit rather than its fiscal deficit, but the point holds).

In summary, then, investors are demanding a higher premium for the added risk of holding gilts. That perceived risk – as the former prime minister Liz Truss has gleefully been pointing out – means that yields on some gilts are now even higher than they spiked following her chancellor Kwasi Kwarteng’s ill-fated mini budget in September 2022.

Investors are also sceptical about the UK economy’s ability to grow its way out of this predicament. While the government’s proposals to invest in infrastructure have been welcomed by investors, they have also noted that much of the extra borrowing being taken on by Ms Reeves in her budget was to fund big pay rises for public sector workers, which – rightly or wrongly – are not perceived to be as good a use of government money as, say, investing in improvements to roads or power grids.

So what does Ms Reeves do?

Well, as the old joke about the Irishman guiding a lost tourist puts it, she “wouldn’t start from here”. The chancellor’s big mistake was to box herself in during the general election campaign by ruling out increases in income tax, employees’ national insurance, VAT or corporation tax. She could easily, for example, have promised to unwind her predecessor Jeremy Hunt’s cut in employee’s national insurance – which was rightly recognised by most voters as a pre-election bribe.

Still, she is where she is, so the chancellor’s main job now will be to convince investors that the UK is on a stable fiscal footing. With the recent rise in gilt yields – the implied government borrowing cost – threatening to eliminate the chancellor’s headroom to meet her fiscal rules, that is likely to mean public sector spending cuts or higher taxes. The former option is more likely than the latter and not least because Ms Reeves is committed to just one ‘fiscal event’ – when taxes are raised – per year and that will be her budget this autumn.

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The Bank of England is also going to have a big part to play here in reinforcing to markets its determination to bringing inflation down to its target range – which means borrowers should not expect as many interest rate cuts in 2025 as they were, say, six months ago.

The Bank may also slow the pace at which it is selling its own gilt holdings (accumulated largely during the ‘quantitative easing’ on which it embarked after the global financial crisis) which would also ease the downward pressure on gilts.

Also coming to the chancellor’s aid, in all likelihood, will be a weakening in the pound which should, all other things being equal, help make gilts more appetising to international investors.

All of this underlines though, unfortunately, that there is only so much the chancellor can do.

Britain’s gas storage levels are “concerningly low” with less than a week of demand available, the operator of the country’s largest gas storage site has warned.

Plunging temperatures and high demand for gas-fired power are the main factors behind the low levels, Centrica said, adding that the need to replenish stocks could lead to rising prices ahead.

The UK is heavily reliant on gas for its home heating and also uses a significant amount for electricity generation.

National Grid data on Friday showed that natural gas accounted for 53% of power in the UK’s system, with renewables offering just 16% of the country’s needs.

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Following the UK’s decision to ditch carbon intensive coal from its energy mix, extra strain is heaped on gas during cold snaps because wind generation can often be lower due to high pressure weather systems.

Earlier this week, the UK’s electricity grid operator issued a rare notice to power firms that sought higher output to prevent a greater risk of blackouts within the network.

As of 9 January, UK gas storage sites “were 26% lower than last year’s inventory at the same time, leaving them around half full,” Centrica said.

“This means the UK has less than a week of gas demand in store.”

The Labour government is investing more heavily in clean energy to bolster the battle against climate change and has shunned pressure to bolster gas supplies through additional North Sea fields.

A Department for Energy Security and Net Zero spokesperson said in response to Centrica’s storage alert: “We have no concerns and are confident we will have a sufficient gas supply and electricity capacity to meet demand this winter, due to our diverse and resilient energy system.

“Our mission to make Britain a clean energy superpower will maintain the UK’s energy security in the long term – investing in clean homegrown power and protecting billpayers.”

Centrica’s Rough gas storage site in the North Sea, off England’s east coast, makes up around half of the country’s gas storage capacity.

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Centrica has previously said it could invest £2bn to upgrade Rough further, but it would need support from the government through a price cap and floor mechanism to make this viable.

Gas storage was already lower than usual heading into December as a result of the early onset of winter and poor wind generation.

Combined with stubbornly high gas prices, this has meant it has been more difficult to top up storage over Christmas.

Centrica said the “situation is echoed across Europe” – where gas storage was at 69% at the start of this week, down from 84% during the same period the previous year.

Unlike Europe, Britain does not have a mandatory gas storage target.

“We are an outlier from the rest of Europe when it comes to the role of storage in our energy system and we are now seeing the implications of that,” said Centrica chief executive Chris O’Shea.

“If Rough had been operating at full capacity in recent years, it would have saved UK households £100 from both
their gas and their electricity bills each winter,” he added.

Gas stores are important as they enable countries to not only guarantee supplies during the transition to renewables but also avoid short term price spikes on wholesale markets.

High storage is also an important tool in moderating price swings.

But the UK has been particularly vulnerable in this space since Russia’s invasion of Ukraine in February 2022, when sanctions meant key taps to Europe were shut off, forcing nations such as the UK and Germany to scramble for supplies.

It has left Europe reliant on the US for liquefied natural gas (LNG) in particular, with Norway a key exporter of natural gas via pipeline to the UK.

The need for Europe as a whole to replenish depleted stocks at the end of winter is among reasons why wholesale prices have remained elevated, leaving households and businesses at the mercy of further hikes to energy bills.

The pound has come under renewed pressure at the end of a torrid week for the UK currency, falling to fresh 14-month lows against the dollar.

Sterling lost almost a cent, to stand just above $1.22 at one stage, on the back of higher support for the greenback after US employment data came in much stronger than expected.

It was seen as denting the prospects for US central bank rate cuts this year – a scenario that tends to be supportive of a domestic currency.

That has not been the case for the UK, however, which is also seeing the prospects for rate cuts this year slip away.

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The pound is on course to have lost more than 2% this week on the back of a growing crisis of confidence in the country’s economic prospects and state of the public finances under chancellor Rachel Reeves.

Financial markets now expect to see just one rate reduction by the Bank of England this year due to stubbornly high inflation and flatlining growth.

The main worry is that the UK is facing a slew of higher prices as businesses have warned they will pass on budget tax hikes from April at a time when a raft of other bills are also due to shoot up.

Corporate lobby groups have declared that firms will also cut investment, jobs and the pace of wage rises to help offset the higher costs from measures such as elevated employer national insurance contributions.

Water and council tax bills are on course to rise by more than the rate of inflation.

Energy costs, it is feared too, are set to rise further amid high demand for gas and weak storage levels Europe wide.

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Ms Reeves is facing a particular headache from increases in the risk premiums demanded by investors to hold UK government debt in the form of bonds – known as gilts.

Yields, the effective interest rate, on 30-year gilts have risen to levels not seen since 1998 this week while other shorter term bonds also saw spikes.

The 30-year yield stood beyond 5.4% on Friday afternoon, up more than six basis points on the day.

A higher cost to service government debt means there is less money for Ms Reeves to spend on other commitments.

The chancellor resisted Conservative and Lib Dem calls to cancel a trade trip to China this weekend and is widely expected to signal that spending cuts are coming to ensure she keeps within her fiscal rules.

The Treasury, on Wednesday, attempted to calm the markets by issuing a statement to insist that the chancellor would not break those commitments.

Bond yields have been rising across many major economies too ahead of the return of Donald Trump to the White House. Investors are baulking at the potential for economic damage caused by threatened trade tariffs.

Susannah Streeter, head of money and markets at Hargreaves Lansdown, said of the US employment data’s impact on the UK: “Worries about interest rates staying higher for longer have been reignited by this stronger-than-expected labour market data.

“Sentiment has soured on equity markets and the bond market strop out is showing signs of intensifying.”