What’s driven the recent rise in UK government bond yields?

The turn of the year has seen a sharp increase in the cost of borrowing UK sovereign debt, as investors sought to offload government bonds (or “gilts”). As of Thursday 9 January, 10-year gilt yields stood at their highest since mid-2008, when the global financial crisis was intensifying, and the yield on longer-dated 30-year debt rose to its highest since 1998. This was accompanied by a sharp fall in sterling, which hit its lowest level against the US dollar in over a year. The simultaneous sell-off in both gilts and the pound echoed developments immediately after the “mini” Budget in 2022, and has prompted concerns over a broader souring in sentiment towards UK assets.

Concerns over growth, inflation and the public finances outlook have pushed yields higher…

The recent move up in gilt yields seemingly reflects ongoing concerns around the scale of fiscal loosening in the government’s last Budget in October 2024 – accelerating a drift upwards in yields that has been apparent since mid-September. However, the jump in the past week is also partly a reaction to a range of survey data released in December and early January, suggesting that the private sector is weakening faster than anticipated. Indeed, the CBI’s own Growth Indicator (a composite of our monthly business surveys) showed that businesses expected a significant fall in output over the next three months, to the greatest extent in over two years. This is raising new concerns that economic growth this year could disappoint relative to the Office for Budget Responsibility’s (OBR) forecasts (who expect GDP growth of 2% over 2025), leading to a worse outlook for the public finances.

Alongside weaker growth, some of the market moves also reflect concerns that inflationary pressures are proving to be more persistent than expected. Inflation data ticked higher in many advanced economies (including the UK) at the end of 2024 – while largely anticipated, this still doesn’t seem to have gone down well with financial markets. Households’ inflation expectations and business’ pricing intentions in the UK have also been creeping higher, adding to concerns of a renewed bout of pricing pressures.

…but global factors are also playing a role

But alongside UK-specific developments, it’s important to note that the rise in gilt yields is part of a broader rise in government bond yields across many advanced economies. In part, this reflects expectations that central banks will reduce interest rates at a slower pace, given that inflationary pressures look more stubborn. This was spurred further by some hawkish comments by the US Federal Reserve chair Jay Powell in December, when he signalled a slower pace of interest rate cuts going forward.

Markets are also pricing in the prospect of bigger deficits elsewhere: through tax cuts by the incoming Trump administration in the US, political turmoil in France (with ratings agency Moody’s downgrading France’s debt outlook in December), and weaker growth prospects in the UK.

Comparisons with the 2022 “mini” Budget look unwarranted

Nonetheless, the scale of increase in sovereign debts in the UK has been greater than those in the rest of the G7. It is also possible that some of the rise in UK yields reflects a more structural deterioration in sentiment towards UK assets over the last couple of years. For example, the fiscal loosening in the October Budget drew comparisons with the 2022 “mini” Budget, despite the scale of additional borrowing in the former being much smaller, and it being accompanied by a new set of fiscal rules and economic projections from the independent OBR. The rise in yields this time around has also been smaller, and has taken place over a longer period, than the instantaneous jump in yields in 2022. Nonetheless, deteriorating investor sentiment would compound market sensitivity to a weakening in economic indicators, lending some credence to recent developments in bond markets.

Markets are likely to “self-correct”, but a more sustained rise in yields should prompt some policy response

Developments in both debt and financial markets more generally are difficult to predict even at the best of times. Nonetheless, there is a good chance that markets will self-correct in the coming weeks, and yields will fall back or stabilise. This could occur particularly once things look more certain (either way) on the global front – for example, as market expectations around monetary policy re-calibrate, greater clarity is forthcoming around the measures imposed by the Trump administration, etc. But we may see a few more flash points along the way, particularly if incoming economic data continues to disappoint.

While a less likely scenario at this stage, we can’t completely rule out a more sustained rise in bond yields, or at least some further volatility in the coming weeks. In this case, the immediate contagion to the real economy would occur via higher borrowing costs, both for government and for households, the latter particularly through mortgage interest payments. Most analysts also believe that the rise in yields seen since October would wipe out the Chancellor’s headroom against her fiscal rules, which may in turn prompt additional fiscal restraint on 26 March, when the OBR is set to unveil its new economic forecasts. But it’s important to note that if developments in bond markets do worsen materially, we’d likely see some forceful rhetoric or policy response – not only from the government but also from the Bank of England, if they judge any further rise in yields to be a threat to financial stability. So far, the Bank have remarked that the movements in gilt markets had been “orderly”, and that they would “continue to watch this space”.

For more detail on the CBI’s view of the economic outlook, please see our latest economic forecast.