How could a bond market crisis unfold?

The rise in gilt yields alone may not be enough to derail the UK economy, but the conditions are falling into place for the next major shock.

The yields on UK government bonds, commonly known as “gilts”, are now consistently the highest among the G7 group of advanced economies. Why is this, and why should the rest of us care?

The numbers alone are disturbing. The cost of new government borrowing for ten years is now around 4.8% in the UK, compared to 4.3% in the US, around 3.6% in France and Italy, 3.4% in Canada, 2.8% in Germany, and just 1.6% in Japan. Longer-dated yields have risen even further in the UK, with the 30-year yield up to around 5.7%.

This is all the more remarkable because UK public debt is not particularly high by international standards. In fact, the ratio of debt to national income in the UK, at around 100%, is far lower than in Italy, at 135%, or Japan, at 240%. Even tiny Greece, with its many recent problems and debt still over 150% of GDP, can borrow at 3.5%.

There are three main reasons why UK borrowing costs are such an outlier.

First, international investors have lost confidence in the UK government’s willingness to take tough decisions to bring borrowing down, especially after the recent failures to curb welfare spending. The prospect of more tax rises is simply reinforcing fears that the UK is stuck in a ‘doom loop’ of sluggish growth and deteriorating public finances.

This credibility gap is a particular problem for the UK compared to many other economies, notably Japan, where the bond market is dominated by domestic investors who are less likely to look elsewhere. Note this part of the story is primarily about the large amount of UK debt that investors will have to be willing to buy, not inflation.

Second, the Bank of England is actively selling government bonds, reversing the previous policy known as “Quantitative Easing” (QE), and it is doing so more aggressively than other central banks. The Bank itself has acknowledged that the new policy of “Quantitative Tightening” (QT) may have added as much as 0.25 percentage points to 10-year gilt yields.

This is especially damaging at a time when there is less demand from DB (defined benefit) pension funds, who traditionally have been big buyers of government bonds.

Third, though, there are fears that higher UK inflation will keep official interest rates higher for longer too, while adding to the cost of inflation index-linked borrowing (of which the UK has a relatively large amount). Conversely, yields in the euro area and Japan are anchored by the relatively low inflation and official interest rates there.

This does not mean that a UK debt crisis is imminent, or even inevitable. The increase in bond yields only affects the cost of new borrowing, which provides at least some breathing space.

The average time remaining before each conventional gilt has to be refinanced is more than 13 years, with only 16% falling due in the next three years. The average time left on index-linked bonds is even longer, at more than 17 years.

What’s more, while 30-year yields are at new multi-decade highs, the government’s Debt Management Office (DMO) is reducing the impact by selling more gilts with shorter maturities rather than locking in the highest rates for a longer period.

In an emergency, the government could also borrow short-term funds through an existing overdraft facility at the Bank of England’, known as the “Ways & Means”. (There is a recent precedent: an agreement in April 2020 allowed for more use of the W&M during Covid, but this was never actually needed.)

And if the markets became disorderly, the Bank of England could step in to buy gilts again – as it did (remarkably successfully) in September 2022. At the very least, the current nervousness in the markets strengthens the case for the MPC to announce a bigger reduction in bond sales at its September meeting, when the QT programme for the coming year is due to be announced.

But this is only partially reassuring. Any of these stop-gaps could backfire if they are seen to underline just how big a mess the public finances are in, and if the government does not use the breathing space to tackle the underlying problems.

There is also the risk of contagion to other markets. This was plain to see in the wake of the mini-Budget in September 2022, when the sell-off in the gilt market was accompanied by a panic in the mortgage market, prompting mortgage lending to dry up. The large falls in the prices of gilts also caused immediate problems for some pension funds. Today, or next week, it might be the equity market.

Sterling is especially vulnerable too if international investors continue to lose confidence, which again could have an immediate impact on other asset prices, on inflation, and on the real economy.

At the moment, the risk of a sterling crisis is being minimised by the fact that other countries are in trouble too – begging the question of which currency the pound would fall against? But that could change if the UK were seen as an even bigger outlier.

Above all, the timing of the latest jitters is especially unfortunate. In a few weeks the Office for Budget Responsibility (OBR) will have to crunch the numbers for the Autumn Budget. Crucially, the OBR’s forecasts will be based on whatever the markets are assuming about the path of interest rates and bond yields over the next five years.

These assumptions could eat further into any remaining headroom or, more likely, make the existing shortfall even larger. This could prompt the Chancellor to announce even larger increases in taxes, again hitting consumer and business confidence hard and having an immediate impact on economic activity.

The upshot is that even if yields simply stabilise at current levels, the cost of government borrowing is painfully high.

In short, a crisis of confidence in the bond market could trigger ripple effects which quickly swamp the entire economy. In my view, the government needs to change course – prioritising spending restraint over more tax increases and refocusing on boosting economic growth. Unfortunately, there is no sign of that happening any time soon.

This is an extended version of a piece first published by The Spectator on 2 September 2025

Ps. I’ve been asked three follow-up questions.

First, what happens if the international credit rating agencies downgrade the UK further?

Normally, changes in sovereign credit ratings make little difference to the cost of borrowing. In part this is because these changes are typically based on factors that are already well known and reflected in market interest rates. What’s more, even if downgraded several notches, the UK ratings would still be in the highest investment grades.

Credit ratings are also far less important than other factors, which helps to explain why countries with lower credit ratings than the UK, such as Japan and Greece, still have much lower borrowing costs.

Nonetheless, with UK debt levels this high and confidence already fragile, the negative headlines from a string of downgrades could still have a significant impact.

Second, who's going to go bust first - the UK, or France?

The correct (if boring) answer is almost certainly 'neither'. But for what it is worth, the markets say it's France: the implied probability of a French default (based on CDS rates) is about twice as high as for the UK.

A simple explanation is that the UK borrows in its own currency, whereas France is constrained (at least in principle) by sharing a currency with the other euro members. The UK government is also not about to lose a vote of ‘no confidence over its Budget plans.

Finally, what exactly is the impact of the rise in bond yields on the Budget numbers?

The OBR has a handy ready reckoner to estimate the fiscal impact of higher borrowing costs.. 👇

Gilt yields are now about 0.5 percentage points higher than assumed in the March forecast. If sustained, this would add around £6bn to the 'black hole'. (The table also allows you to estimate the impact of higher than expected short rates and inflation, which could easily double this figure.)