Why have UK bonds sold off again?

Everyone knows bonds sold off sharply at the time of the Truss mini budget, with markets saying spending and borrowing were too high and with the Bank at the same time putting up the short-term interest rates and selling a lot of bonds itself. What fewer know is the 10 year and 30-year UK bond interest rates the government has to pay have been quite a bit higher all this year to date than the worst day under Truss. Markets expect and worry about the government spending and borrowing more, and note the Bank is still busy selling bonds it owns. UK bonds are at low prices with higher interest rates than European or even US ones as a result of these fears. 

Markets are concerned that debt interest costs are already more than £100 bn a year, with the government borrowing more to pay the interest. Debt interest soared when inflation ran up to 11%, as part of the debt is indexed to the inflation rate adding to the costs of servicing it. Now inflation has come down the costs have stayed high. They have been driven there by the government having to roll over or refinance retiring debt at much higher rates than the original borrowings. The government has to pay interest on much bigger borrowings as each year this decade the government had added considerably to the debts by borrowing more.

Bond markets do not like uncertainty about how a government will run its budget. They do not like changes to a budget forcing a government to relax the purse strings more. To meet the new and easier fiscal targets the incoming Chancellor set, the government announced a cut to pensioner fuel grants which it was forced to largely cancel. It proposed substantial welfare reform with a useful saving in costs, only to see the governing party MPs throw it out when they were asked to vote for it. The Chancellor is still in post and is thought by the markets to want to hit her own targets. She has now to decide how she can recover the position as she looks for £6.5bn to replace the lost savings on welfare and pensioners.

These are not the only two problems she has to stay within her controls. The forecast assumes recovery of public sector productivity which has fallen a lot this decade. It assumes some control over the growth of future welfare entitlement and benefit levels. The Treasury cannot duck the need to control welfare and restore some lost productivity to make the numbers add up.

The biggest spender with the fastest growth in spending is the NHS. The latest ten-year health Plan promises to turn the page on the 10% productivity decline since 2019 and achieve 2% improvement a year. We await the details of how this will be achieved. The government is backing AI as a means to transform public sector costs and quality. We can look forward to another good boost to US big tec companies revenues as the government rolls out large spending programmes on AI. We may have to wait for these projects to be completed, and the bills paid before we start to see benefits in fewer staff and lower overall running costs.

Meanwhile welfare costs and numbers of claimants will rise without some change of policy. The government has given itself a year or so to study how to contain numbers qualifying for a range of disability benefits. It wants to get a lot of people into work to lower their benefit needs, but they face declining vacancies as National Insurance hits big employers. The private sector is itself applying more AI which may reduce its need for extra staff.

Bond investors were right to take a cautious view of public finances. The battles are just beginning. The government lost the first two over pensioner and disability payments. There will need to be more ahead. Come the autumn there will doubtless be talk of a balanced package of measures including selective tax rises and spending cuts. Relatively high rates on UK bonds provides some support to the UK bond market. It offers investors a better running return than the main European and US bond markets, with less risk in the shorter dated bonds. No-one can say they did not know there are problems balancing the books. 

About the author 

The Rt. Hon Sir John Redwood has been a long-standing member of the EPIC Investment Partners Advisory Board. 

John is a well known commentator on governments and economies, with long experience of investment markets. Trained as an analyst at Robert Flemings, he moved to N.M. Rothschilds where he became a Manager and Director of pension and charitable funds and Head of Equity Research. He was seconded to become Head of the Downing Street Policy unit before chairing a large, quoted UK industrial business. He served as an MP and a government Minister.  

In 2007 he set up Pan Asset with a colleague, an investment management business that pioneered active/passive funds and models in the UK. Following the sale of the business to Charles Stanley, a quoted investment manager in the City, he became their Global Chief Strategist advising on non-UK markets and economies. He also ran a demonstration fund for the FT, writing articles about it and illustrating the use that can be made of ETFs in portfolios. 

He is now an adviser to EPIC, providing insights into the big investment issues of the day from the debt and spending problems of the major governments to the green and digital revolutions which have so much impact on equity markets. He is a Distinguished Fellow of All Souls College, Oxford, where he helps with their Endowment investments and gives occasional lectures on modern economics and politics.