Pound falls and bond yields rise but UK rules out emergency action

The pound has fallen to its lowest level in more than a year, while UK borrowing costs have also soared to a 16-year high. Economists are warning that the rising costs could lead to further tax increases or spending cuts as the government struggles to adhere to its self-imposed rule of not borrowing to fund day-to-day spending.

Responding to an urgent question in the House of Commons, Treasury Minister Darren Jones said there was "no need for an emergency intervention" and that markets were "continuing to operate in an orderly way." But shadow chancellor Mel Stride stated: "Higher debt and lower growth are rightly causing real concern for the public, businesses, and markets."

Jones said: "It is normal for prices and yields of government bonds to change when there is wider volatility in global financial markets, including in reaction to economic data." He also added that the government’s decision to borrow only for investment was "non-negotiable." But Stride countered: "The government’s decision to let borrowing rip means that their own tax rises will ultimately be swallowed up by higher borrowing costs, doing nothing for the British people."

On Thursday, the pound fell 0.9% against the dollar to $1.226. Borrowing costs surged earlier in the day before falling back in mid-afternoon. Normally, when borrowing costs rise, the pound strengthens, but economists said wider concerns about the strength of the UK economy were driving the pound lower. Governments typically spend more than they raise in tax revenue, and to cover the shortfall, they borrow money, which must be paid back with interest. One way to borrow money is by selling financial products called bonds.

Mohamed El-Erian, chief economic adviser at Allianz, told the BBC's Today program that the increase in borrowing costs means the government is paying more in interest on its debt and "that eats up more tax revenue, leaving less money for other things." El-Erian added that this also slows down economic growth, "which also hurts revenue." He said: "So if this continues, the Chancellor will have to consider either raising taxes or further cutting spending, and that will affect everybody." The government has said it will not reveal any information about spending or taxes until March when its independent forecaster publishes its official borrowing forecasts.

Revised figures at the end of last year showed that the economy had seen zero growth between July and September. This was the latest in a string of disappointing figures, including rising inflation to November, with prices rising at their fastest rate since March. In December, the Bank of England said the economy was likely to perform worse than expected in the final three months of 2024. At the same time, it kept interest rates unchanged at 4.75% due to "high levels of uncertainty in the economy." Globally, government borrowing costs have risen in recent months as investors worry that US President-elect Donald Trump’s plans to impose new tariffs on imports from Canada, Mexico, and China will push up inflation.

The US has also seen similar rises in government borrowing costs as the UK. "This could be a global sell-off, but it presents a unique problem for the UK Chancellor, who wants to put more money into public services without raising taxes again or breaching his self-imposed fiscal rules," said Danny Hewson, head of financial analysis at AJ Bell.

Some may wonder about the impact of higher government bond yields on the mortgage market, particularly after what happened following Liz Truss’s mini-budget in September 2022. Although yields are higher now than they were then, they have been climbing slowly over several months, whereas in 2022, they surged within days. This rapid rise led to lenders quickly withdrawing deals while trying to work out what interest rates to charge. But Simon French, chief economist at Panmure Gordon, said that the situation was too complex for a direct comparison between Truss and Reeves.

"The main driver of higher yields under Truss was UK policy. It was a combination of the mini-budget (which was her fault) and the energy crisis (which was not her fault). But the mini-budget was the biggest factor," French explained. "This time, global concerns about debt levels are pushing yields higher everywhere, particularly in the US, which is not Reeves’ fault. But there is also pessimism about the impact of her budget on growth, which is slowing rather than accelerating the economy. That is her fault."