The biggest victim of rising global interest rates: the UK

Strong economic data from the United States has triggered a global bond sell-off, with both European and American bond markets declining, leading investors to question whether central banks can significantly cut interest rates as expected.

Among them, the UK has become the biggest "loser," suffering heavy blows in both the bond and currency markets this week. UK bonds have fallen for five consecutive days, with the benchmark ten-year UK bond yield reaching a new high not seen since the 2008 financial crisis, and the 30-year UK bond yield hitting a new high since 1998, rising more than those in the US and Germany. The British pound has fallen for four consecutive days, hitting a one-year low.

This is undoubtedly "adding insult to injury" for the UK, as the rise in yields against a backdrop of economic weakness will significantly increase government borrowing costs. Deutsche Bank estimates that by 2030, UK government debt expenditures could increase by about £50 billion. This may force the government to cut spending or raise taxes, further suppressing economic growth.

In light of the current situation, some investors are betting that the pound will weaken further, believing that the UK may be entering a period of heightened stagflation risk, where high inflation and slowing economic growth create a dilemma for UK policy.

On one hand, the Bank of England needs to continue raising interest rates to curb inflation; on the other hand, the government may have to adopt expansionary fiscal policies to stimulate the economy. Neil Mehta, an investment manager at RBC BlueBay Asset Management, stated, "The choices for UK policymakers are very limited, and they will face difficult decisions in the future."

Why is the market continuing to sell off?

The sell-off in the UK bond market stems from growing investor concerns about the economic outlook.

First, the UK's fiscal situation is worrying, with the debt-to-GDP ratio reaching its highest level since the 1960s. Second, to fill the budget deficit, the market expects the UK to issue a large amount of bonds. The UK government has stated that it plans to issue £297 billion in government bonds this fiscal year, and analysts expect that the issuance in the new fiscal year starting in April may exceed £300 billion. According to UBS estimates, to absorb this supply, UK private investors need to increase their holdings of government bonds by 9%, while the corresponding ratios for the EU and the US are 5.7% and 6.8%, respectively.

In addition, there are signs of accelerating inflation in the UK, forcing the Bank of England to maintain high interest rates. At the same time, the withdrawal of pension institutions, which are long-term buyers, has left the market without important support. As funding conditions improve, the demand for UK government bonds from pension funds has significantly decreased, and the market needs to attract more price-sensitive buyers to fill the gap.

In addition to economic factors, political uncertainty has also exacerbated market volatility. Comments from Tesla CEO Elon Musk have sparked a diplomatic row, and UK Prime Minister Keir Starmer, during a press conference this week, intended to focus on the national health system but spent a significant amount of time responding to Musk's call on social media for his removal.

At the same time, the new Trump administration in the US threatens to impose tariffs on overseas goods, raising concerns among UK investors. Given the UK's heavy reliance on international trade, if global supply chains are disrupted or retaliatory tariffs drive up prices, the UK economy could suffer severe damage Moreover, the UK is highly reliant on foreign investors for financing. Former Bank of England Governor Mark Carney described this phenomenon as dependence on the "kindness of strangers." However, recent signs of foreign investors withdrawing their investments have become increasingly evident. Viraj Patel, Deputy Research Director at Vanda Research, pointed out:

“When UK government bond yields rise and the pound falls, it is a dangerous signal, usually indicating that foreign investors are pulling out. The yields have broken decades-high levels, triggering automatic sell orders set by investors, which may exacerbate market sell-offs.”

Huw Davies, Fixed Income Investment Manager at Jupiter Asset Management, stated:

“This is a global reassessment of the fiscal conditions of various countries. If there is a competition for capital internationally, the US is in a more advantageous position because people always need dollars. The UK, on the other hand, needs to prove its worth.”

No Truss-style panic observed, today's UK market response is more restrained

The current market turmoil inevitably recalls the situation in the UK in 2022.

At that time, then-Prime Minister Truss attempted to cover the fiscal gap caused by tax cuts by increasing government borrowing, which triggered market panic. Investors lost confidence in the sustainability of the UK's finances, leading to a massive sell-off of UK government bonds, with the 10-year UK bond yield rapidly climbing to nearly a decade-high after the tax reform proposal, and the pound briefly falling to 1.0224, a new low since 1985. Ultimately, Truss had to abandon her plan and resign.

In contrast, the market response this time has been much more moderate. Analysts pointed out that unlike the strong backlash against the tax cut plan in 2022, the UK government currently promises to reduce the deficit and control debt, which has somewhat eased market sentiment. Jupiter Asset Management's investment manager Davies remarked:

“The UK's problems are indeed serious, but they have not reached a crisis level. Unlike during the Truss era, the current government respects market rules more. The government realizes it cannot fight against the market.”

Nevertheless, the market sell-off has still affected the reputation of Chancellor of the Exchequer Reeves. Reeves had previously promised to drive economic growth and restore fiscal discipline, but investors remain skeptical