UK government bonds remained under pressure with little sign of respite after Liz Truss’s Conservative leadership victory, and experts warned her policy plans will be key to settling the rattled gilts market and reining in soaring public borrowing costs.
The new prime minister will take up the post facing yet more woes for the creaking public finances after last month’s biggest sell-off in UK government bonds – or gilts – since 1994 sent government borrowing costs soaring.
Concerns over Britain’s economic and political prospects sparked the gilt rout, which means a rise in the yield – or interest rate – charged on them, in turn leading to high government borrowing costs.
The yield on 10-year gilts – which is a proxy for the effective interest rate on public borrowing – edged slightly lower after Ms Truss was announced as the new Tory leader, but at 2.94% at the time of writing, it still hovers perilously high to the 3% level not seen since early 2014.
Russ Mould, investment director at AJ Bell, said: “Financial markets express their faith – or lack of it – in a country and its economic and political prospects through how much they charge it to borrow and how they value its currency.
“In each case traders and investors are already turning away, presumably because they do not like what they see.”
He warned that if Ms Truss cannot rein in the gilt sell-off, she may find her plans for big tax cuts scuppered.
Mr Mould said the rise in 10-year gilt yields is “in recognition of the surge in inflation, and also the Bank of England’s shift to raising interest rates and toward quantitative tightening”.
“That adds to the Government’s interest bill on its £2.4 trillion debt and potentially limits scope for spending or tax cuts.”
He added: “The new prime minister will find themselves potentially trapped between the lesser of two evils of inflation on one side and recession on the other.
“If the financial markets like what they hear then that may help to hold gilt yields in check, the yield curve to steepen and the pound to rally.”
But Susannah Streeter, a senior investment and markets analyst at Hargreaves Lansdown, said bond markets are fearful of what Ms Truss might unleash in her bid to prop up the UK economy.
She said: “The worry is that, far from pulling the economy out of recession, the policies of Liz Truss risk a prolonged period of stagflation.
“Being a tax-cutting prime minister might go down well among Conservative Party members, but it’s a risky strategy for the longer term stability of the economy.”