Bond yields surge to 2008 levels in blow to Hunt’s tax cutting dreams

Government borrowing costs have soared to the highest levels since 2008 in a blow to Jeremy Hunt’s hopes of cutting taxes before the election.

Yields on 10-year government bonds hit a 15-year high of 4.7pc on Thursday as investors bet that interest rates will need to rise even higher to tame inflation.

Gilt yields have now surpassed both the peak seen in the aftermath of last autumn’s mini-Budget and the most recent high of 4.66pc recorded in July.

Surging borrowing costs and rising interest rate expectations will cost the Chancellor an extra £12bn a year by 2027, economists said.

This would more than wipe out the Chancellor’s slim fiscal headroom and mean tax cuts before next year’s election would be difficult without spending cuts.

The forecasts also put Prime Minister Rishi Sunak at further risk of failing in his pledge to get debt falling.

Borrowing costs have jumped after higher-than-expected wage growth and stubbornly high core inflation data published this week.

Althea Spinozzi, fixed income strategist at Saxo Bank, said: “Markets are realising that the Bank of England doesn’t have inflation under control and the economy is deteriorating fast.”

City traders are now betting the Bank of England will be forced to take interest rates to a peak of 6pc and hold them there until at least next summer. A week ago, markets were expecting a peak between 5.5pc and 5.75pc.

Borrowing costs globally have risen sharply in recent days as investors grow concerned about how long inflation will take to get under control.

In the US, Treasury yields have also jumped to their highest point since 2008 on Thursday, while German bunds were close to levels not seen since 2011.

The combination of surging gilt yields and high interest rates will push up the cost of UK government borrowing by £12bn by 2027-28 compared to the Office for Budget Responsibility’s (OBR) March forecasts.

The extra cost is almost double the slim budget headroom of £6.5bn the Chancellor gave himself in March.

Karl Williams, deputy research director at the Centre for Policy Studies, said: “It is fair to say that that headroom could be wiped out twice over.”

He added: “From the current position, where interest rates are one percentage point higher than anticipated, it does look like debt will be rising by the end of the forecast window, or at least it will not be falling.”

It presents another setback to the Chancellor’s ambitions to cut taxes before next year’s election. Carl Emmerson, deputy director at the Institute for Fiscal Studies, said higher taxes were in fact more likely.

Mr Emmerson said: “The idea that we’re going to see tax cuts being implemented that prove to be sustainable looks pretty unlikely.

“Much more likely, over the next two or three years, we will see measures announced that will bring a net tax rise.”

Lloyds Bank said 13 out of 14 sectors of the economy it tracks suffered  a drop in new orders in July, while 10 reported a fall in output.

More UK sectors saw their output contract than at any time in the last eight months, the bank said, blaming high interest rates and inflation.

Nikesh Sawjani, Senior UK Economist at Lloyds Bank Corporate & Institutional Banking, said: “This month’s data clearly indicates a slowdown in activity across the economy, largely driven by a further material weakening in demand.”

Mr Hunt’s £6.5bn margin was already the smallest fiscal headroom set aside by any Chancellor since the OBR was established 13 years ago.

The financial blow from higher borrowing costs could be softened by higher income tax receipts thanks to fiscal drag.

High economic growth would also solve the problem. However, Mr Williams said: “Given where we’re at now, that seems unlikely.”

A Treasury spokesman said: “This report reaffirms our need to be disciplined with the public finances. Additional borrowing right now would fuel inflation, push up mortgage rates and hike up debt interest repayments – diverting money away from our public services.

“We were right to protect families and businesses from the pandemic and Putin’s energy shock, but we must now stick firmly to our plan to halve inflation, grow the economy and reduce debt.”