The UK’s long-term borrowing costs surged to the highest level in more than a quarter of a century, raising the prospect of Chancellor of the Exchequer Rachel Reeves needing to raise taxes again in order to meet her fiscal rules.

The yield on 30-year gilts climbed as much as six basis points to 5.24% on Tuesday after the first of a string of bond sales due over the coming weeks. The yield was last higher in 1998 when Tony Blair was prime minister and the Bank of England was slashing interest rates from a six-year peak to contain the global fallout from the Asian currency crisis and Russian debt default.

Today’s Labour government is ramping up borrowing in an effort to improve Britain’s public services and boost investment in large infrastructure projects. Reeves has also committed to maintain discipline but was given just £9.9 billion ($12.4 billion) of headroom against her main fiscal rule despite lifting taxes by more than £40 billion in her Oct. 30 budget.

Reeves tweaked her self-imposed fiscal rules as the new administration sought to protect its credibility with markets while allowing for more public investment. The main rule prevents the chancellor from borrowing for day-to-day spending by 2029-30, which she has said is non-negotiable. She also opted for a slightly looser debt rule than her Conservative predecessor, vowing to reduce “net financial debt” as a share of GDP by 2029-30.

“If market pricing sticks then the fiscal rules are probably going to be breached in the UK and they’re going to have to come back and do more,” said Jamie Rush, Bloomberg’s chief European economist. Reeves has insisted she will not raise taxes again, but some of her Cabinet colleagues, including Prime Minister Keir Starmer, have been less equivocal.

Capital Economics said Reeves is “within a whisker” of breaking her fiscal rule and even a modest increase in interest-rate expectations and 20-year gilt yields could wipe out the chancellor’s headroom altogether.

“Reeves could soon face a nasty choice of breaking her fiscal rules or announcing more tax rises and/or spending restraint at a time when the economy is already weak,” said Ruth Gregory, an economist at the firm.

The UK’s Debt Management Office sold £2.25 billion on 30-year notes on Tuesday, paying a yield of 5.198%. The auction gave mixed signals of demand. While its oversubscription rate was the weakest since December 2023, at a bid-to-cover ratio of 2.75, the difference between the average and lowest yield accepted — known as tail — was just 0.3 basis points, indicating solid appetite for the notes.

The DMO will also sell £4.25 billion of new five-year bonds on Wednesday. While shorter-term yields aren’t yet hitting multi-decade highs, they have also shot up since the Labour government announced plans to sell £297 billion of bonds this fiscal year — the second-highest on record.

The five-year UK yield is up about 20 basis points since the budget, and the benchmark 10-year rate has risen around 30 basis points to trade at the highest since October 2023.

“The anticipated heavy supply of Gilts over the next few weeks helps explain the poor performance of long-dated Gilts so far,” said Emmanouil Karimalis, a strategist at UBS.

Bank of England
The prospect of fewer interest-rate cuts from the Bank of England than initially expected has also weighed on the notes. Traders are betting the UK central bank will deliver only two quarter-point reductions this year, compared to bets on more than three at the start of last month.

The market moves show the extent to which the government is treading a fine line, as it tries to keep investors on side and dispel the memory of former Conservative Prime Minister Liz Truss’ disastrous mini-budget of 2022. Reeves already received a warning from bond vigilantes in October when yields surged in response to the prospect of bigger debt auctions.