The government borrowing costs are at their highest level since 2008. This is a blow for Jeremy Hunt’s hopes to cut taxes before the elections.
Investors bet on rates to go even higher in order to curb inflation.
Gilt yields now surpass both the peak recorded after the mini-Budget of last fall and the latest high of 4,66pc, which was recorded in July.
Economists say that the rising borrowing costs and interest rates will cost the Chancellor £12bn extra a year in 2027.
It would also be impossible to cut taxes before the next election without cutting spending.
These forecasts put Prime Minister Rishi Sunder at greater risk of not being able to achieve his goal of reducing debt.
The cost of borrowing has risen after this week’s data, which showed a stubbornly high core rate of inflation and higher than expected wage growth.
Althea Spinozzi is the fixed income strategist for Saxo Bank. She said: “Markets have realised that the Bank of England does not have inflation under control, and the economy has deteriorated fast.”
City traders now bet that the Bank of England will be compelled to raise interest rates to a maximum of 6pc, and to hold them there at least until next summer. Markets were expecting interest rates to peak between 5.5pc-5.75% a week ago.
Investors are worried about the inflation rate and how long it will take for it to be under control.
On Thursday, Treasury yields in the US also reached their highest level since 2008. German bunds are close to levels last seen in 2011.
In 2027/28, the combination of high interest rates and surging gilt yields will increase the cost of borrowing for the UK government by £12bn compared to March’s forecasts by the Office for Budget Responsibility (OBR).
The additional cost is nearly double the budgetary headroom of £6.5bn that the Chancellor himself gave in March.
Karl Williams, deputy director of research at the Centre for Policy Studies said: “It’s fair to say this headroom could easily be erased twice over.”
He said: “From current positions, where interest rates were one percentage point above what was expected, it looks like debt will rise by the end or the forecast window.
This is a setback for the Chancellor in his plans to reduce taxes before next year’s elections. Carl Emmerson said that higher taxes are more likely.
Mr Emmerson stated: “The idea of tax cuts that are sustainable and that can be implemented in the future seems pretty unlikely.”
“It is more likely that in the next two to three years we will hear about measures which will result in a tax increase.”
Lloyds Bank reported that 13 of the 14 sectors it tracks in the economy experienced a decline in new orders during July. Ten of these sectors also reported a decrease in output.
The bank blamed high interest rates and inflation for the contraction of output in more UK sectors than any other time during the past eight months.
Nikesh Sawjani is Senior UK Economist for Lloyds Bank Corporate & Institutional Banking. He said, “This month’s figures clearly indicate a slowdown across the economy. This is largely due to a materially weakening of demand.”
The £6.5bn that Mr Hunt set aside was the smallest headroom for fiscal policy since the OBR’s establishment 13 years ago.
Fiscal drag could help to reduce the financial impact of higher borrowing costs by increasing income tax receipts.
A high economic growth could also solve the issue. Williams, however, said that this was unlikely, given where we are now.
Treasury spokesperson said: “This Report reaffirms the need for discipline in public finances. A Treasury spokesperson said: “This report reaffirms our need to be disciplined with the public finances.
“We did the right thing by protecting families and businesses against the pandemic, and Putin’s energy scare, but now we have to stick to our plan of halving inflation, growing the economy, and reducing debt.”