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On January 13, 2025, the spread between the yields on 10-year government bonds and German bonds reached 230 basis points. This was four basis points higher than the peak reached on 27 September 2022, when Liz Truss was Prime Minister. The UK may not be heading towards a borrowing crisis. But her position is fragile. The Government must work to strengthen confidence in the UK's integrity and common sense.
Interest rates rose across the G7. Even in Germany, the yield on long-term 30-year Bunds rose by about 290 basis points in the period from January 15, 2021 to January 15, 2025. In the United States, the rise was 300 basis points, and in France, 350 basis points. . Unfortunately, the rise in UK yields was the highest among the G7, at 440 basis points. UK 30-year bond yields reached 5.2 per cent in mid-January. This was the highest level in the G7, while German yields were only 2.8 percent and French yields were still only 3.9 percent. But yields in the US were not far behind levels in the UK, at 4.9 per cent, perhaps because of the huge structural fiscal deficit in the global economic superpower.
In short, yields on long-term debt in the UK have risen more and reached higher levels than in peer countries. Yields on 30-year government bonds were 56 basis points higher than yields in Italy on January 15. Moreover, while yields in the UK rose by 78 basis points in the previous year, yields in Italy did not rise at all. This is embarrassing.
The crucial question is why interest rates rose. The big change was in the real interest rate, not in inflation expectations. In the case of the UK, we have reasonably robust measures of both, from returns on index-linked and conventional government bonds. The difference between the two refers to inflation expectations and inflation risk perceptions.
This data shows that UK real interest rates jumped from a low of -3.4 in early December 2021 to a peak of 1.3% on 14 January 2025. One could describe this as a post-period normalization of real interest rates Very low. The jump in real interest rates closely matches the rise in yields on traditional government bonds, suggesting that changes in inflation expectations have been surprisingly small.
So what do these real and nominal yields tell us about the stability of the UK's public debt? If the debt-to-GDP ratio is to stabilize when the real interest rate exceeds the economy's growth rate, the government needs to achieve a primary fiscal surplus (the balance between revenues and spending before interest payments). A real rate of 1.3 percent allows for a modest primary deficit if growth is consistently higher. International Monetary Fund data It shows that this was precisely the rate of growth trend in the UK between 2007 and 2024. Therefore, debt stability requires consistent initial balances. Fortunately, according to Office of Budget ResponsibilityAccording to the October budget analysis, the primary budget is expected to move toward a surplus of just under 1 percent of GDP in the last three years of this decade. This would be consistent with the near stability of the net debt-to-GDP ratio, as the Office for Budget Responsibility shows in its debt forecasts.
The implication is that the situation is manageable. However, there are still risks. The first is that real and nominal global interest rates could rise further, perhaps due to further jumps in investment or defense spending, or greater awareness of a range of political, monetary and financial risks. The UK's particular fragility is that the country runs persistent capital account surpluses, which makes it highly dependent on foreign financing, unlike, say, Japan. This is also true for the United States. But the latter is the main borrower for the rest of the world.
Another risk facing the UK is that GDP growth, already low, may slow further. The policy of achieving primary fiscal surpluses may then become impossible. Another risk is that the net debt-to-GDP ratio is already close to 100 percent. That's hardly low. What is comforting is that it is lower than the levels in Japan, Italy, France and the United States. But it is much higher than it was two decades ago. Finally, there is the “Trump risk,” especially threats to impose high tariffs against an open economy no longer within the European Union.
In short, the UK's situation is fragile. The government must maintain the confidence of its creditors. It is important not to adopt policies that raise doubts about their sound logic. How the budget tax hike did just that. The same applies to regulatory developments, especially in the labor market. The government will have to toughen its stance on this Current spending In its next review or consider imposing higher taxes.
The UK must focus on resilience and growth. Panic is unnecessary, but the era of cheap borrowing is over. Politics must respond.
