The Pound has slumped to its lowest level against the US dollar in over a year, as surging government borrowing costs have triggered warnings that mortgage rates are set to rise. The latest economic developments present a triple blow to Chancellor Rachel Reeves, who has been under pressure since her Autumn Budget raised taxes and borrowing to boost public spending.
On Thursday morning, Sterling fell nearly 1%, dropping to just under 1.23 US Dollars, its weakest point since November 2023. This decline comes amid a deepening crisis in UK government bonds, also known as gilts. The yield on 10-year gilts, which reflect the cost of government borrowing, surged by eight basis points to 4.89%. This is the highest rate seen since 2008.
The rise in borrowing costs isn’t limited to shorter-term debt. The yield on 30-year gilts also reached its highest level since 1998, climbing to 5.39%, an increase of three basis points. As borrowing becomes more expensive, analysts are warning that these rising costs will be felt across the economy, particularly in the housing market.
Paul Dales, Chief UK Economist at Capital Economics, predicted that UK mortgage rates will likely increase from around 4.5% in December to over 5% in the coming weeks. This uptick in mortgage rates, combined with rising borrowing costs across other sectors, is expected to dampen economic activity.
The falling Pound, rising borrowing costs, and warnings of higher mortgage rates represent a significant challenge for Chancellor Rachel Reeves. Her Autumn Budget, which saw a £40 billion increase in taxes and £30 billion more in borrowing, has been criticised for its handling of the country’s finances. However, the new Labour government has defended the budget as a necessary step to address the challenges faced by Britain’s public services, particularly the NHS.
Yet, economists are sounding the alarm that the current surge in borrowing costs could diminish the Chancellor’s £10 billion fiscal cushion, leaving her with little room for manoeuvre. With public borrowing becoming more expensive, Reeves could face the difficult choice of either scaling back public spending or raising taxes again in the spring.
In response to the growing concerns, the Treasury has insisted it will maintain “an iron grip” on the public finances. This comes after a sell-off in the UK debt markets on Tuesday and Wednesday, which pushed the yield on 30-year British government bonds to a 26-year high.
Opposition politicians, such as Shadow Chancellor Mel Stride, have criticised Reeves for the economic strain caused by the government’s policies. Stride took to Twitter to claim that the tax hikes introduced in Reeves’ budget were “making it more expensive for the government to borrow.” He added, “We should be building a more resilient economy, not raising taxes to pay for fiscal incompetence.”
Some analysts have drawn parallels between the current market turmoil and the fallout from the ill-fated mini-budget of former Prime Minister Liz Truss in 2022. However, the market moves this time have been less sharp, and there has been no sign of the same kind of panic among institutional investors that forced the Bank of England into emergency bond purchases two years ago.
Treasury Minister Darren Jones reassured Parliament that the UK bond markets “continue to function in an orderly way,” noting that underlying demand for UK debt remains strong. Despite these reassurances, the overall economic uncertainty continues to weigh heavily on the market, as global concerns about inflationary pressures and the political situation in the US add to the mix.
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Reeves, who was scheduled to travel to China on Thursday for an official visit, has stated that she does not plan any further significant tax increases after the hike in employer National Insurance. The tax rise has been blamed for stalling business growth and discouraging hiring, contributing to the UK’s sluggish economic performance.
Globally, there has also been a wider sell-off in government bonds in recent months, partly due to concerns that US President-elect Donald Trump may introduce inflationary tariff policies. This has had a ripple effect on economies worldwide, adding to the pressure on UK financial markets.
Kathleen Brooks, Research Director at XTB, acknowledged that while the pace of the bond sell-off had eased on Thursday, the Pound’s weak performance highlights ongoing concerns. “The market remains under pressure,” she said, “and the Pound’s reaction indicates that there is still a lot of uncertainty in the air.”
As the UK government navigates these turbulent economic waters, the country faces the prospect of higher mortgages, rising borrowing costs, and a potential squeeze on public spending. With inflationary pressures and global financial uncertainty still looming large, the coming months will be crucial in determining how the UK economy responds to these challenges.
