Why UK borrowing costs are rising: a surge in long-term gilt yields​

Long-dated gilt yields accelerate higher

​The cost of borrowing for the UK government is climbing steadily, and at the heart of this trend is a sharp increase in yields on long-dated gilts - government bonds with maturities beyond ten years. This development reflects a complex interplay of global monetary shifts, weakening demand for UK sovereign debt, and lingering inflation concerns.

​Although the UK is a prominent example of this trend, similar dynamics are at work across other developed economies, suggesting structural changes in bond markets rather than purely domestic factors.

​Over the past four years, UK government bond yields have risen across the curve, from 2-year to 10-year maturities. But what is drawing the most attention is the acceleration in 30-year gilt yields, which are pulling away from shorter maturities.

​Weekly UK 2-, 5-, 10- and 30-year Gilt yield chart 

​This divergence highlights deeper issues related to long-term inflation expectations and structural shifts in the supply and demand for government bonds that extend well beyond typical monetary policy cycles.

​Supply and demand imbalance drives yield surge

​One major driver of rising yields is supply imbalance. Governments, including the UK, continue to run large deficits and issue more debt, despite rhetoric around fiscal restraint. Simultaneously, the buyer base for this debt is shrinking.

​During the quantitative easing (QE) era, central banks acted as price-insensitive buyers, purchasing vast quantities of government bonds to keep yields low and stimulate growth. Now, however, those same institutions are engaged in quantitative tightening (QT) - not only have they stopped buying, but they are actively reducing their bond holdings.

​That withdrawal alone represents a major shift in the market dynamic, removing a crucial source of demand that had artificially suppressed yields for over a decade.

​In parallel, corporate defined benefit (DB) pension schemes, once steady buyers of long-term gilts to match their liabilities, are also stepping back. Rising interest rates have significantly improved their funding levels, reducing the need for these long-duration assets.

​Inflation expectations reshape long-term outlook

​Another key contributor is persistent inflation uncertainty. While central banks have made progress in taming headline inflation, core inflation remains sticky, and investors are no longer willing to ignore this risk.

​For long-duration assets like 30-year gilts, even small shifts in inflation expectations can have outsized impacts. Investors now demand higher yields as compensation for long-term inflation risk, especially when the income from these bonds is fixed.

​This inflation sensitivity is magnified over longer time horizons, making long-dated gilts particularly vulnerable. In effect, the market is adjusting to a world in which inflation is no longer viewed as reliably anchored around central bank targets.

​The shift represents a fundamental change in investor psychology after years of ultra-low inflation and aggressive central bank intervention that kept long-term yields artificially suppressed.

​Implications for equity markets and economic conditions

​The surge in bond yields is not without consequences. One major risk is that higher yields eventually divert capital away from equities, particularly when government bonds begin to offer relatively attractive, low-risk returns.

​For example, a 6% annual return on long-dated gilts could lure investors away from volatile equity markets, especially in risk-off environments where capital preservation becomes a priority over growth seeking.

​Secondly, persistently high borrowing costs tighten financial conditions across the economy. From mortgage rates to corporate financing, the cost of credit rises when long-term yields climb, potentially choking off investment and spending.

​This tightening effect could slow economic growth and even contribute to market corrections, as higher discount rates reduce the present value of future corporate cash flows and make growth investments less attractive.

​Corporate and household borrowing costs rise

​The rise in government borrowing costs inevitably feeds through to corporate and household borrowing rates, as these typically price off government bond yields plus a credit spread.

​Mortgage rates, already elevated from previous lows, face additional upward pressure as long-term gilt yields rise, potentially affecting housing market activity and consumer spending patterns.

​Corporate bond issuance becomes more expensive, potentially constraining business investment and expansion plans as companies face higher financing costs for long-term projects and capital expenditure.

​This broader tightening of credit conditions creates a feedback loop where higher government borrowing costs contribute to economic weakness that could ultimately affect tax revenues and require even more government borrowing.

​Investment strategies for rising yield environment

​Looking ahead, investors now face a crucial question: when does this dynamic hit a tipping point? Rising bond yields may at some stage to act as a headwind for both risk assets and the broader economy.

​As a result, some market participants are turning to "monetary havoc" hedges like gold, while also favouring defensive stocks that are seen as more resilient to the potential fallout. This rotation is taking place despite the FTSE 100 hitting a record high this week.

​The search for assets that can provide protection against both inflation and rising yields has become a central theme for portfolio construction in the current environment.

​Value-oriented equity strategies may become more attractive as growth stocks face headwinds from higher discount rates, while dividend-paying stocks could benefit if their yields become competitive with fixed-income alternatives.

​Trading opportunities in volatile rate environment

​For traders and investors looking to navigate the rising yield environment, several approaches merit consideration given the multiple crosscurrents affecting markets.

1. ​Research the relationship between bond yields, equity valuations, and economic conditions to understand how rising rates might affect different asset classes.
2. ​Consider how your portfolio allocation might need to adjust to account for higher yields and changing risk-return profiles across asset classes.
3. ​Open an account with IG by visiting our website and completing the application process.
4. ​Access bond markets, equity indices, and alternative assets through our trading platform to implement your strategy.
5. ​Implement appropriate risk management and diversification given the potential for continued volatility as monetary conditions evolve.

​CFD trading and spread betting provide flexible approaches for expressing views on interest rate movements and their impact on different asset classes.

​For longer-term investors, share dealing in value-oriented companies or dividend-paying stocks may provide better protection against rising yields than growth-focused strategies.

​The current surge in UK borrowing costs is not a short-term anomaly - it reflects a fundamental shift in the post-QE, inflation-aware world. Understanding these drivers will be crucial for navigating what could be a prolonged period of elevated rates and increased market volatility.

​This environment requires investors to reconsider traditional portfolio allocation models and potentially embrace strategies that account for the new reality of higher structural yields and reduced central bank support for financial markets.