Rising Gilt Yields Puts UK In IMF Zone

Rachel Reeves faces the prospect of imposing further large tax increases this autumn after a sharp rise in government borrowing costs squeezed her ability to fund day-to-day spending.

The yield on 30-year UK government bonds climbed close to its highest level in almost three decades last week, continuing a steady march upwards since the spring. The move places the Chancellor in a difficult position ahead of her first full budget, expected in November.

Borrowing costs surge

Yields on gilts have risen in tandem with a global sell-off in long-term government debt, driven largely by rising US Treasury yields. The benchmark 10-year gilt yield rose by 0.06 percentage points to 4.74 per cent, while shorter-dated borrowing costs also increased. Because yields move inversely to prices, the figures indicate investors are demanding higher returns to hold UK government debt.

Elevated yields increase the interest burden on public finances and reduce the fiscal headroom available under the Chancellor’s rules, which require that daily government spending be met entirely from tax revenues. Economists warned that Reeves may have to raise taxes by up to £30bn in the coming budget to remain compliant.

That would come on top of the £40bn of tax increases already announced last October.

OBR timetable pushes budget into November

The Treasury has yet to instruct the Office for Budget Responsibility to begin preparing forecasts. Under legislation, the OBR requires ten weeks’ notice, making November the earliest date for the budget.

The watchdog’s projections will be critical in determining whether Reeves can meet her fiscal targets. Its modelling incorporates expected economic growth, unemployment and inflation, as well as prevailing borrowing costs. Rising yields both raise the government’s interest bill and depress growth prospects, putting pressure on the Chancellor’s position.

Nomura, the Japanese investment bank, said that while public finances have broadly developed in line with OBR expectations since March, “a large tax-raising budget remains likely”.

Potential tax reforms under review

Officials are considering significant changes to the UK tax framework. Options under discussion include the creation of a new property tax regime, the abolition of capital gains tax relief on primary residences, and alterations to inheritance tax thresholds.

Such measures would target wealthier households but would risk provoking a political backlash. Reports of the proposals have already sparked debate about a looming “tax squeeze” on the middle class.

Bank of England complicates the picture

The rise in gilt yields has come despite three interest rate cuts by the Bank of England this year, which would normally push borrowing costs lower. In August, the Monetary Policy Committee reduced the base rate by a quarter point to 4 per cent.

However, a string of stronger-than-expected economic data has prompted markets to question whether further cuts will materialise. Inflation rose to 3.8 per cent in July, while a private-sector activity index hit its highest reading in a year.

Pantheon Macroeconomics said the latest figures made the August rate reduction “increasingly difficult to justify”. Market pricing now suggests there may be no further cuts in 2025, although traders still see a small chance of one more quarter-point move in November.

Catherine Mann, an external member of the MPC, said she had opposed the August cut and favoured holding rates steady owing to “persistent inflation persistence”.

Fiscal bind for Reeves

The interaction between monetary and fiscal policy leaves Reeves in a tight corner. Higher borrowing costs mean the Treasury must set aside a greater share of revenues to service debt, while slower growth reduces tax receipts. To retain credibility with investors, Reeves has pledged to stick to the fiscal framework she set out in opposition, which emphasises balanced day-to-day spending.

If the OBR concludes that the government is on course to breach those rules, Reeves will have little choice but to announce new revenue-raising measures in the budget. Economists say the scale of the gap could be between £20bn and £30bn, depending on how markets evolve over the coming weeks.

Global backdrop adds to pressure

The UK’s fiscal challenges mirror those faced by other advanced economies, where long-term borrowing costs have risen in response to large deficits and investors demanding higher returns. US Treasury yields have spearheaded the sell-off, pulling up European bond markets.

For Reeves, the challenge is particularly acute because she has already committed to higher public investment and a cautious approach to spending restraint. That leaves taxation as the main lever available to balance the books.

Political implications

Any decision to overhaul property or inheritance taxation would carry political risks for Labour. While such measures could be justified on grounds of fairness, they would provoke resistance among homeowners and affluent voters. Conservatives have already signalled they will oppose changes to the capital gains exemption on primary residences, calling it an attack on “ordinary families”.

Nevertheless, analysts say the Chancellor’s room for manoeuvre is shrinking. “With long-term yields at multi-decade highs, Reeves cannot count on borrowing to fund her priorities,” said one senior economist. “If she sticks to her rules, significant new tax measures are inevitable.”

Outlook

The coming weeks will determine how severe Reeves’s fiscal challenge becomes. Should gilt yields stabilise or fall, the required tax increases may be smaller. But if global markets remain unsettled and inflation stays elevated, the Chancellor could face one of the most difficult budget rounds in recent memory.

Investors are already bracing for a revenue-raising package in November. Markets will scrutinise both the scope of new measures and Reeves’s ability to maintain confidence in the government’s fiscal management at a time of heightened volatility.

For now, the combination of higher borrowing costs, sticky inflation and political pressure has left the Chancellor with few easy choices.