LONDON — The recently established British government is grappling with significant backlash due to tax hikes, unpopular financial decisions, and various political controversies, just six months after assuming power. Compounding these challenges are rising borrowing costs, which jeopardize the government’s left-leaning agendas.
Since September 16, the yield on the U.K.’s 10-year government bonds has surged by over 1.1 percentage points, fueled by worries about lackluster economic growth and persistently high inflation. This surge has escalated the nation’s borrowing costs to their highest rate since the financial crisis of 2008.
As borrowing becomes more expensive, the government faces reduced budgets for crucial services, including the National Health Service, military, emergency services, and educational institutions. Though officials were granted a brief relief with a slight dip in inflation rates in December, failure to improve the situation could prompt Prime Minister Keir Starmer to reconsider his pledges to enhance spending while avoiding tax increases on working-class citizens, promises that significantly bolstered his Labour Party’s landslide victory in July.
The current economic turmoil is influenced not only by global factors, such as the anticipated return of U.S. President-elect Donald Trump, who has advocated raising tariffs on imports, but also by the government’s miscalculations. Treasury chief Rachel Reeves had built her economic framework on the expectation that growth would naturally increase tax revenues.
As the situation evolves, many are questioning what has ignited this turmoil. Global bond investors are increasingly anxious about Trump’s tariff strategies potentially leading to escalated consumer prices in the U.S., which could, in turn, compel the Federal Reserve to maintain higher interest rates for an extended period. Susannah Streeter, head of money and markets at Hargreaves Lansdown, pointed out that elevated consumer prices usually result in higher borrowing costs as investors seek to protect their returns from the impacts of inflation.
Only months prior, investors anticipated that the Federal Reserve would implement several rate reductions this year; now, they are only expecting a single cut. The Institute for Fiscal Studies, a think tank focused on U.K. fiscal policies, observed that the recent increase in gilt yields seems primarily a response to global dynamics rather than any specific actions from the U.K. government. Gilts, which are British government bonds, are traded on the London Stock Exchange.
Britain is not alone in facing these rising borrowing costs; multiple countries, including the U.S., are similarly affected. However, Britain’s situation is particularly precarious owing to its economic state and high levels of national debt. Consumer price inflation slightly decreased to 2.5% for the year ended in December, yet remains significantly higher than the Bank of England’s target of 2%. Current statistics reveal that the U.K. economy has essentially stagnated, with the latest reports indicating flat growth in the gross domestic product (GDP) over the three months leading to September.
This stagnation can be partly attributed to the government’s decision to elevate payroll taxes and implement stricter workplace regulations, discouraging some businesses from investing or expanding their workforce. Streeter emphasized that the U.K. is currently experiencing heightened stagnation fears, with an economy perceived to be stagnating and inflation diverging from the Bank of England’s target, leading to increased nervousness among investors regarding government debt.
In terms of national debt, the U.K. government’s obligations stood at over 98% of economic output as of November, marking the highest ratio since 1963 when the country was still addressing debts from World War II. Reeves had anticipated that economic growth would mitigate debt levels, simultaneously introducing fiscal rules designed to prevent borrowing for daily expenditures by 2030, alongside promises to refrain from raising taxes on working individuals. Rising borrowing costs complicate these objectives significantly. However, experts suggest that abandoning these commitments would be challenging for Reeves, given the heavy reliance on international financial flows to manage debt and address the trade deficit with major partners like China.
In response to these financial pressures, the new Labour administration has had to embrace bold strategies, including engaging with China to enhance trade. Reeves recently undertook a three-day visit to China in search of investment opportunities, a move which triggered mixed reactions back home. Despite criticisms over national security implications, Reeves argued that ignoring China would mean missing out on crucial economic growth opportunities that Britain cannot afford to overlook.
Looking ahead, if borrowing costs persist at elevated levels, Reeves may soon find her options limited, constraining her capacity for expenditure. A major policy development may occur on March 26, when she is slated to present an update to Parliament regarding the nation’s financial standing, alongside new assessments from the Office for Budget Responsibility on economic forecasts. Streeter reassured investors that financial markets tend to settle over time, despite their inherent volatility in the short term.
