Pound slumps as government borrowing costs highest since 2008 financial crisis

Sterling fell by as much as 1.1% to 1.233 against the dollar, its lowest level since April 2022, while the yield on the benchmark 10-year UK gilt climbed by roughly 12 basis points to a peak of 4.81%

The pound has plummeted to its lowest value in nine months following a surge in government borrowing costs.

This comes amid an ongoing sell-off in the bond market due to investor fears over stagflation and a new wave of bond sales. The increase in the cost of servicing government debts could hinder future Labour spending plans and is a potentially concerning indicator of how investors currently view fiscal sustainability in the UK.

Sterling fell by as much as 1.1% to 1.233 against the dollar, hitting its lowest level since April last year. The yield on the benchmark 10-year UK gilt, which reflects the cost of government borrowing, rose by approximately 12 basis points to a peak of 4.81%.

This is the highest reading since the 2008 financial crisis. The rise in gilt yields inversely affects the price of these government bonds, which consequently fell on Wednesday. The cost of long-term borrowing also continued to climb, with the yield of 30-year gilts reaching their highest level since 1998.

These increased around 10 basis points to a peak of 5.36%. Globally, there has been a broader sell-off in government bonds in recent months due to concerns that US President-elect Donald Trump might implement a tariff policy that would inflate many international economies.

US Treasury yields also significantly increased on Wednesday, with the 10-year Treasury yield rising to 4.69% – its highest since April last year.

The US economy's unexpected resilience has stoked doubts over further cuts to interest rates. Meanwhile, the UK experienced a surge in yields as the Debt Management Office (DMO) sold £4.25bn worth of notes on Wednesday, following the previous day’s sale of £2.25bn in notes.

Last year, the DMO had anticipated selling around £296.9bn in notes for the fiscal year 2024-25. This spike in government borrowing costs spells out a challenge for Chancellor Rachel Reeves, tightening the Treasury’s capacity for increased public expenditure in face of possibly escalating interest charges.

Post-autumn Budget, Ms Reeves was estimated to have a slender financial leeway of £9.9bn in to adhere to her revised fiscal measures. Despite announcing a hefty £40bn package aimed at hiking taxes to finance more spending, the dilemma of higher debt interest means the Chancellor might have to cut back on her spending plans or generate additional revenue to comply with the fiscal rules.

However, only last year, the Chancellor promised there would be just one tax-changing fiscal event annually. On Wednesday, the Prime Minister’s official spokesman declined to speculate, stating: "I’m obviously not going to get ahead ... it’s up to the OBR (Office for Budget Responsibility) to make their forecasts and they’ll make their forecasts at the spring statement in the usual way."

"But I would say when the Government came into office we made very clear why it’s so important to manage the public finances to deal with the £22bn black hole that was in the public finances because having stability in the public finances is precursor to having economic stability and economic growth."

Shadow chancellor Mel Stride said that the Chancellor’s hefty spending and borrowing in the recent Budget are "making it more expensive for the government to borrow".

"We should be building a more resilient economy, not raising taxes to pay for fiscal incompetence," he argued. "Labour’s decision to allow debt to continue rising ever higher leaves us vulnerable even to small changes in markets."

Michiel Tukker, senior European rates strategist at ING, expressed that borrowing costs might not decrease quickly.

He commented: "Myriad factors contributed to the stretch higher, including Labour’s spending ambitions, sticky inflation, higher US rates and supply pressures."

"We still see gilt yields settling lower later in the year, but as long as these factors linger, a change in direction may take some time."