The UK's borrowing costs are soaring once again, as the Iran conflict casts a shadow over economic growth. This is despite the government's recent optimism about inflation and spending deficits. The conflict has sent shockwaves through the market, causing a dramatic shift in investor sentiment. Since the weekend's outbreak, the odds of the Bank of England cutting interest rates have plummeted from 80% to just 30%.
The rising costs are attributed to the fear of inflation, driven by soaring oil and gas prices. This is a double-edged sword, as it comes at a time when businesses and households are still recovering from a prolonged period of high inflation. Analysts predict that higher energy costs will lead to price increases, forcing central banks to delay interest rate cuts until later this year.
The situation is further complicated by the UK's plans to issue a massive £252.1 billion in government bonds for the 2026-2027 financial year. This is a significant increase from the previous year's issuance, and the market is reacting with caution. The conflict in the Middle East has caused a surge in bond yields, with two-year gilts yields jumping 16 basis points to 3.8%.
Economists like David Aikman and Kathleen Brooks highlight the timing of the spring statement as unfortunate, given the current market volatility. The statement's optimistic tone about borrowing costs has been overshadowed by the crisis, with analysts warning of further pressure on the budget outlook.
The Office for Budget Responsibility (OBR) had predicted a significant drop in borrowing costs, but the latest bond yield increases have reversed those gains. David Miles, the chief economist, admits that the outlook for inflation is now more uncertain, especially with the recent spikes in oil and gas prices linked to Middle East attacks.
