UK 30-year borrowing costs rise to highest since 1998

By David Milliken

LONDON (Reuters) - Britain's long-term government borrowing costs hit their highest since 1998 on Tuesday, adding to the problems facing finance minister Rachel Reeves who plans to borrow hundreds of billions of pounds to finance higher public investment and spending.

Long-term borrowing costs around the world have risen following the COVID-19 pandemic and Russia's full-scale invasion of Ukraine in February 2022, which caused inflation to surge.

However, British yields have risen further in recent weeks as most investors expect the Bank of England to cut interest rates by only about half a percentage point this year with inflation likely to hover above the central bank's 2% target.

The United Kingdom Debt Management Office sold 2.25 billion pounds ($2.8 billion) of benchmark 30-year gilts to investors at an average yield of 5.198% at an auction on Tuesday. This was the highest yield for a 30-year gilt since the DMO sold one at 5.790% at its first auction in May 1998.

Two-year gilts - which are more sensitive to short-run expectations for BoE interest rates - sold for higher yields in 2023.

In trading between investors after the auction, the 30-year yield peaked at 5.221%, the highest since August 1998 and 4 basis points higher on the day.

Expectations of U.S. tax cuts and high spending when Donald Trump becomes president, as well as potential inflation from new trade tariffs, have also pushed up U.S. yields with a knock-on impact for Britain and Germany.

REEVES FACES TOUGH TASK ON BUDGET RULES

In the past month British 30-year government bond yields have been over 2.5 percentage points higher than in Germany - a level only exceeded in September 2022 during market turmoil after former prime minister Liz Truss' "mini budget".

Higher borrowing costs are likely to make it harder for Reeves to meet her budget rules and possibly require her to increase taxes again, having already hit employers with higher social security contribution requirements.

Thirty-year gilt yields are around 0.3 percentage points higher than yields for U.S. Treasuries, broadly in line with their average over the past two years and in the early 2010s.

Some analysts said ahead of the auction that gilt yields looked too high.

Aviva Investors said its team had "a preference for gilts on the view that the Bank of England will cut rates more than the market expects in 2025 on a softer inflation outlook and weaker than expected growth".

RBC said it saw little scope for 30-year yields to move higher in the short run as that would hinge on markets further reducing their expectations for BoE rate cuts this year.

"Whilst this move may indeed come later in the year, we don't see there being enough evidence currently for the market to really pursue such a narrative - particularly ahead of the very significant macro uncertainties which stem from Trump's upcoming inauguration," it said.

($1 = 0.7966 pounds)

(Reporting by David Milliken; Editing by William Schomberg and Emelia Sithole-Matarise)