UK borrowing costs surge past 5% as Iran conflict escalates

Created at 14 Jul · 10:56 AM2 sources↑ Market-relevant2 events

IN SHORT

The yield on the UK's 10-year government bond climbed as much as seven basis points to over five percent, a level not seen since the Iran war began. The escalation of tensions between Iran and the US, including the closure of the Strait of Hormuz, has driven oil prices higher and increased government borrowing costs across developed economies.

Key Numbers

5%UK 10-year government bond yield

7 basis pointsIntraday rise in UK 10-year bond yield

9 percentBrent crude's daily gain on Monday

May 2020Last time Brent crude saw such a large daily gain

5 basis pointsRise in 10-year US Treasury yield

4.5%UK two-year gilt yield

10 basis pointsRise in UK two-year gilt yield

30 JulyBank of England's next interest rate meeting

40 percentImplied chance of Federal Reserve rate hike this month

Who's Involved

Andy Burnham

Incoming UK Prime Minister

Donald Trump

US President reinstating blockade

Bank of England

Central bank facing rate hike pressure

Federal Reserve

Central bank potentially hiking rates

Daniel Mahoney

Senior UK economist at Handelsbanken

Kathleen Brooks

Research director at XTB

UK borrowing costs surge past 5% as Iran conflict escalates

↳ Why This Matters

The escalating conflict in the Middle East and the subsequent rise in borrowing costs pose a significant challenge to the UK's fiscal stability and economic outlook, potentially impacting interest rate expectations and government spending.

Key facts

UK 10-year government bond yields surpassed five percent for the third time since the Iran war began.
The collapse of the Iran-US ceasefire led to renewed strikes and a surge in oil prices.
The Strait of Hormuz was blockaded by the US, impacting shipping.
Higher inflation and stubborn price rises are driving up bond yields.
Traders are pricing in a Bank of England interest rate hike by year-end.
The market also anticipates a potential Federal Reserve rate hike this month.

The UK's borrowing costs have surged past five percent for the 10-year government bond, a level not seen since the onset of the Iran war, as tensions between Iran and the US escalate. The fragile ceasefire shattered, leading to renewed strikes and a significant jump in oil prices. This geopolitical instability has caused government bond yields to rise across developed economies, with the UK particularly exposed due to its reliance on imported energy and persistent inflation.

Higher inflation typically compels traders to demand higher interest rates for holding bonds, as rising prices can erode real returns. Investors also anticipate central bank interest rates remaining elevated for longer when inflation is stubborn. Daniel Mahoney, senior UK economist at Handelsbanken, noted the volatility of UK gilts since the start of the Iran War, expecting them to remain the highest in the G7.

The sell-off has also impacted shorter-dated bonds, with the two-year gilt yield climbing above 4.5 percent for the first time since mid-May. This has led traders to increase their bets on the Bank of England raising its central interest rate at its next meeting on July 30. Kathleen Brooks, research director at XTB, stated that the energy price spike means markets are pricing in more interest rate hikes, with a full hike expected from the Bank of England by year-end.

The market also anticipates the Federal Reserve potentially raising interest rates this year, with markets implying a 40 percent chance of a hike at their upcoming meeting. The sharp rise in borrowing costs presents a significant fiscal challenge for incoming Prime Minister Andy Burnham, who is set to take office soon. The previous 60-day ceasefire had eased pressure on public finances.

Frequently asked questions

The collapse of the ceasefire between Iran and the US, leading to renewed strikes and a blockade of the Strait of Hormuz, caused oil prices to surge and government bond yields to increase.

The UK's heavy reliance on imported energy and stubborn underlying inflation make its borrowing costs more exposed to geopolitical developments and market expectations of higher interest rates.

Traders are increasing bets on the Bank of England raising its central interest rate, with a full 25 basis point hike priced in by year-end.

Markets are implying a 40 percent chance that the Federal Reserve will opt to hike interest rates at its upcoming meeting.

What Happens Next

01The Bank of England is expected to consider interest rate hikes at its next meeting.

02The Federal Reserve may also opt to raise interest rates.

03The new UK Prime Minister will face fiscal challenges due to increased borrowing costs.

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How It Developed

Bank of England Governor Andrew Bailey identified low economic growth as the UK's main challenge.

The ceasefire between Iran and the US shattered, leading to renewed strikes.

Oil prices surged, with Brent crude jumping more than nine percent in a single session.

The US military conducted further offensive actions against Iranian military sites.

Donald Trump reinstated the US blockade of Iranian ships in the Strait of Hormuz.

The UAE reported two tankers being struck by Iranian missiles.

UK 10-year government bond yields climbed as much as seven basis points to over five percent.

US Treasury yields also increased, with the 10-year yield climbing more than five basis points.

Sources

Bank of England warns Burnham of UK economy’s ‘big issue’City AM

UK borrowing costs soar as Iran ceasefire collapsesCity AM