UK Borrowing Costs Skyrocket Amid Iran Conflict Concerns
The UK's borrowing costs have surged yet again, fueled by investors' fears that the ongoing Iran conflict will stifle growth across major industrial economies. This comes as a shock to the system, as the market had been anticipating a more stable economic outlook.
The primary concern is the potential surge in inflation, driven by rising oil and gas prices, which could hit businesses and households just as they are recovering from a prolonged period of elevated inflation. Analysts predict that higher energy costs will lead to price increases, forcing central banks to delay interest rate cuts until later this year.
The situation is further complicated by the recent spike in Brent crude prices, which surpassed $83 per barrel on Tuesday, up from around $60 in December. This rapid increase in oil prices is a direct result of the conflict in the Middle East.
Initially, the government had hoped that the decline in inflation to 3% and a reduced annual spending deficit would contribute to lower interest rates on UK debt. However, the positive borrowing figures heralded by Rachel Reeves in her spring forecast speech were overshadowed by the growing anxiety over the Middle East crisis.
Since the conflict erupted over the weekend, market expectations for the Bank of England to cut interest rates have plummeted from 80% to just 30%. This shift in sentiment has led to a significant rise in government borrowing costs, with two-year gilt yields jumping 16 basis points to 3.8% on Tuesday, although they later stabilized near a 10-point increase.
Industry experts weigh in on the situation. David Aikman, director of the National Institute of Economic and Social Research, highlights the impact of the Middle East crisis on the UK's borrowing position. He warns that if the crisis persists, higher energy prices will contribute to inflation, further increasing borrowing costs and putting pressure on the budget outlook.
Kathleen Brooks, a research director at currency trader XTB, emphasizes the unfortunate timing of the spring statement. She notes that UK bond yields are soaring, and this time, it's not Rachel Reeves' fault. The bond market is pricing in the worst-case scenario of a prolonged war in the Middle East and an energy-price inflation shock.
Paul Dales, the chief UK economist at Capital Economics, points out that the Bank of England might be more sensitive to the inflationary risks associated with the conflict compared to other central banks. Last month, the Bank's monetary policy committee held rates at 3.75%, with policymakers expressing a desire to wait and observe the pace of inflation before making further cuts.
The Office for Budget Responsibility (OBR) had initially projected a significant decline in borrowing costs, benefiting public finances. However, the recent bond yield increases have reversed these gains. David Miles, the chief economist, acknowledges that the outlook for inflation has become more uncertain due to the sharp increases in oil and gas prices linked to the Middle East attacks.
In response to these challenges, Britain plans to issue a substantial amount of government bonds, totaling £252.1 billion in the 2026-27 financial year, according to the UK Debt Management Office. This figure surpasses the primary dealers' median forecast of £245 billion in gilt issuance, which is still lower than the £303.7 billion issued in 2025-26.
