Unlock Editor’s Digest for free
Roula Khalaf, editor of the FT, picks her favorite stories in this weekly newsletter.
On January 13, 2025, the spread between the yield on the 10-year gilt and the German Bund reached 230 basis points. That was four basis points higher than the peak reached on September 27, 2022, when Liz Truss was Prime Minister. The UK is probably not going into a debt crisis. But his position is fragile. The Government must strengthen confidence in a healthy UK and its own sanity.
Interest rates rose in the G7. Even in Germany, the yield on the ultra-long 30-year Bund rose by 290 basis points between January 15, 2021 and January 15, 2025. In the US, the increase was 300 basis points, and in France, it was 350 basis points. Unfortunately, the rise in UK yields was the highest in the G7, at 440 basis points. British yields on 30-year gilts reached 5.2 percent in mid-January. That was the highest level in the G7, while German yields were just 2.8 percent and French yields were still just 3.9 percent. But US yields weren’t that far behind UK levels, at 4.9 per cent, likely due to huge structural fiscal deficits in the global economic superpower.
In short, long-term debt yields in the UK have risen higher and reached higher levels than in comparable countries. Yields on 30-year gilts were as much as 56 basis points higher than Italian yields on January 15. Moreover, while UK yields rose by 78 basis points in the previous year, they did not rise at all in Italy. That’s embarrassing.
The key question is why rates have gone up. The big change is in the real interest rate, not inflation expectations. In the case of the UK, we have relatively robust measures of both, from index-linked and conventional gilt yields. The difference between the two indicates inflation expectations and inflation risk perception.
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 percent on 14 January 2025. This could be described as a normalization after a period of extremely low real rates. The jump in real interest rates largely corresponds to the rise in conventional gilt yields, suggesting that changes in inflation expectations have been surprisingly small.
So what do these real and nominal yields say about the stability of UK public debt? If the debt-to-GDP ratio is to stabilize when the real interest rate exceeds the growth rate of the economy, the government must achieve a primary fiscal surplus (the balance between income and spending before interest payments). A real rate of 1.3 percent allows for a modest primary deficit if growth is consistently higher than that. IMF data show that this was exactly the UK’s trend growth rate between 2007 and 2024. So debt stability requires consistent primary balance sheets. Fortunately, according to Office of Budget and AccountabilityAccording to an analysis of the October budget, the primary budget is projected to move into a surplus of just under 1 percent of GDP in the last three years of this decade. This would be consistent with the net debt to GDP ratio being roughly stable, as the OBR shows in its debt forecasts.
The implication is that the situation is manageable. However, there are risks. One is that global real and nominal interest rates could rise further, perhaps due to further jumps in investment or defense spending or increased awareness of a range of political, monetary and financial risks. A UK-specific fragility is that the country runs persistent capital account surpluses, making it highly dependent on foreign financing, unlike, say, Japan. This is also true for the USA. But the latter is the main borrower for the rest of the world.
Another risk for the UK is that GDP growth, which is already low, could slow further. The policy of running primary fiscal surpluses could then become impossible. Another risk is that the ratio of net debt to GDP is already close to 100 percent. This is hardly low. Comfortably, it is below the levels in Japan, Italy, France and the US. But it is much bigger than two decades ago. Finally, there is the “Trump risk”, especially threats of high tariffs against an open economy that is no longer within the EU.
In short, the situation in Great Britain is fragile. The government must retain the trust of its creditors. The key is not to adopt policies that raise doubts about their good sense. As taxes were raised in the Budget it did. Likewise, the development of regulation, especially in the labor market. The government will have to tighten its stance current consumption in your upcoming audit or consider higher taxes.
The UK must focus on resilience and growth. Panic is unnecessary, but the era of cheap borrowing is over. Politics must respond.
