The Treasury has said UK financial markets are functioning “in an orderly way” despite the pound plunging to its lowest level for over a year after a rout in the bond markets.
Government borrowing costs increased further on Thursday morning, piling more pressure on the Labour Government’s fiscal plans.
Uncertainty over fiscal stability and wider global pressures caused sterling to weaken, with the pound falling nearly 1% to just under 1.23 US dollars – its lowest level since November 2023.
The FTSE 250 stock index also slid to its weakest level for nine months.
Treasury Minister Darren Jones said that the Government’s fiscal rules are “non-negotiable” but warned that “public services will have to live within their means”.
It comes after economists warned that Chancellor Rachel Reeves could be forced into further tax hikes or cuts to spending plans to meet UK fiscal rules due to a potential rise in the Government’s debt interest bill.
Yields on government bonds – which reflect the cost of government borrowing – continued to rise, up eight basis points to 4.89 for 10-year gilts, which is the highest since 2008.
The cost of longer-term borrowing also continued to rise, with the yield of 30-year gilts at their highest level since 1998.
They were up around three basis points to a peak of 5.39%.
The rise in gilt yields has an inverse effect on the price of these government bonds, which are falling as a result, with some saying the current market woes echo those seen in the fallout from the disastrous mini-budget of former prime minister Liz Truss in 2022.
The rise in the cost of servicing government debts could cut into Labour’s expected financial headroom in a potentially worrying sign of how investors see fiscal sustainability in the UK.
Mr Jones told MPs in Parliament on Thursday: “In recent months, moves in financial markets have been largely driven by data and geopolitical events, which is to be expected as markets adjust to new information.
“UK gilt markets continue to function in an orderly way and underlying demand for the UK’s debt remains strong.”
He stressed that the Government witnessed strong demand in its latest tranche of planned gilt sales on Wednesday.
Shadow chancellor Mel Stride said: “Despite what (Mr Jones) says about international factors, the premium on our borrowing costs compared to German bonds recently hit its highest level since 1990.
“With these rising costs, regrettably the Government may now be on course to breach their fiscal rules and the Chancellor has committed to no further tax rises.”
The gilt rout has been sparked by investor worries over rising government borrowing and the mounting threat of so-called stagflation, where the economy sees rising inflation combined with stalling growth.
Globally, there has also been a wider sell-off in government bonds in recent months in the face of worries that US President-elect Donald Trump could introduce a tariff policy which would be inflationary for many international economies.
US Treasury yields have also been moving firmly higher after reports of resilience in the US economy have cast doubts over expectations for further cuts to interest rates.
Kathleen Brooks, research director at XTB, said while still under pressure, the pace of the “relentless” bond sell-off had eased on Thursday.
But she stressed the pound’s reaction shows ongoing concerns in the market.
“The UK’s fiscal position continues to look perilous,” she said.
“The Chancellor is expected to make a speech in the coming days, where she may focus on public sector spending cuts rather than further tax increases to meet her fiscal rules.
“However, the rhetoric from the Labour Government is one reason we are in this mess in the first place, and there are no guarantees that Reeves will be able to calm the market.”
The rise in government borrowing costs poses a challenge for Ms Reeves, putting pressure on the Treasury’s ability to increase public spending amid the prospect of higher interest costs.
After the autumn budget, Ms Reeves was left with only £9.9 billion of headroom to meet her revised fiscal rules. This came despite a £40 billion package of tax increases to fuel higher spending.
Higher debt interest costs may mean the Chancellor would need to trim spending plans or bring in more revenue than expected to meet the fiscal rules.
The Chancellor committed last year to having only one fiscal tax-changing event a year, which is expected in the autumn, leaving many to expect that she will opt to rein in spending plans in her March fiscal statement.
