UK borrowing costs hit highest for 18 years as uncertainty over PM continues

UK borrowing costs hit highest for 18 years as uncertainty over PM continuesGovernment borrowing costs jumped on Tuesday amid uncertainty over the future of Prime Minister Sir Keir Starmer.

The effective interest rate on borrowing over 10 years briefly hit 5.13%, near levels last seen during the 2008 global financial crisis.

Financial markets have been on edge due to fears that the Iran war will push up inflation and lead to interest rate hikes, but the possibility of a change of leadership in the UK and perceived risk of looser public spending has further unsettled some investors.

Some 80 Labour MPs have called for Sir Keir to resign following poor election results last week, but the PM has told his cabinet to "get on with governing".

The UK's main stock index, the FTSE 100, fell 0.5% with shares in British banks leading the declines amid concerns of a tax raid by a potential new administration, and the pound also fell 0.5% against the dollar to $1.35.

While all governments have seen borrowing costs rise since the Iran war, the UK has experienced elevated rates compared to countries with economies similar in size.

Investors have watched the speculation surrounding Sir Keir's future closely, with analysts suggesting there is a risk that potential replacements might loosen public spending and increase borrowing by the government.

The prime minister and Chancellor Rachel Reeves have consistently committed to "iron clad" rules on borrowing in a bid to reassure markets their economic plans are credible.

Analysts at Capital Economics said they believed UK borrowing costs would rise and the pound would weaken if there was a change at the top of the Labour party.

"The UK's already fragile fiscal position means that investors will be on edge for any signs of fiscal loosening," they said.

"The likely replacements for Starmer/Reeves would probably not be as fiscally disciplined."

They suggested all frontrunners to potentially challenge Sir Keir – Andy Burnham, Angela Rayner and Wes Streeting – would "probably raise public spending".

Governments get most of their income from taxes, but often want to spend more money than taxes raise.

To cover that gap, they borrow money from investors and issue something called a bond or gilt, which is a loan the government promises to pay back at the end of an agreed time.

But a major area investors seek when lending governments money is a degree of certainty and confidence that they will get a return.

On Tuesday, borrowing costs – as shown by the bond yield, or interest rate – across two, five, 10 and 30-year terms were all higher as the prime minister's future was in peril. The yield on 30-year bonds hit 5.80%, the highest since 1998.

The 10-year gilt is the benchmark for government bonds, while the two and five-year gilts have an influence on fixed-rate mortgage rates of the same time frame.

"Elevated oil prices add inflationary pressure to a bond market already frazzled by concerns that a different UK prime minister might take a different view on borrowing, relaxing fiscal rules or extending them," said Anna Macdonald, investment strategy director at Hargreaves Lansdown.

"This would mean that investors, of which 25-30% are overseas buyers of UK government bonds, demand a higher risk premium."

The amount of interest government pays on existing public debt is linked to inflation and interest rates on bonds. The sum has been rising in recent years and now accounts for about £1 in every £10 the government spends.

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