Why Britain's long bonds now cost the most since 1998

Britain just sold its longest bonds at the steepest price in a generation — and the buyers queued. On September 8th the government auctioned £4.25bn ($5.7bn) of thirty-year gilts at a yield of 5.82%, the highest borrowing cost it has paid at any sale since the Debt Management Office began operations in 1998. Yet investors did not refuse the offer. They tendered more than £85bn, roughly twenty times the amount on sale, in what dealers called "bumper demand".

The contrast matters. A market that refuses to lend to a government is a crisis. A market that lends eagerly but only at record prices is something else, and it is the more interesting condition. It is also the condition Britain is in: the yield on the thirty-year gilt has touched 5.9%, and the twenty-year has traded above 5.8%, both at levels not seen since the late 1990s.

The temptation is to read this as the 2022 sequel — the mini-budget of Liz Truss, which sent gilt yields soaring and forced the Bank of England to intervene. That reading would be wrong. The Bank's own analysis of the past year in long rates finds that inflation expectations have stayed anchored; the driver of the rise has been something called the real term premium. A term premium is the extra compensation a lender demands for locking money up for three decades rather than rolling it over in short-term debt. It is the price of uncertainty about the future — inflation, fiscal policy, the credibility of a government. What Britain is experiencing is not a loss of faith in its currency. It is a repricing of how much the market must be paid to hold duration risk.

Why has that price risen so far? Because the gilt's most devoted customer has largely stopped buying. For two decades the long end of the British bond market was underpinned by defined-benefit pension funds running liability-driven investment (LDI) strategies. These funds held bonds to match their future pension promises, come what may; they were buyers for structural reasons, insensitive to price. Rising interest rates have since made many of these funds fully funded, so the need to hedge melted away. The marginal buyer of long gilts is now a price-sensitive global allocator with a relative-return mandate, equally free to buy American Treasuries, and facing a worldwide glut of government issuance. When a buyer with no natural reason to hold leaves, the compensation everyone else demands goes up.

The consequences are landing sooner than the market drama suggests. Each rise of a quarter-point in gilt yields adds roughly £2.5bn a year to Britain's debt-interest bill, which the Office for Budget Responsibility already forecasts at £109bn — 8.4% of all public spending. That arithmetic is colliding with the Chancellor's budget, due on October 28. Analysts at Pantheon Macroeconomics estimate the bond rout has halved John Healey's fiscal headroom, from £23.6bn at the spring statement to about £13bn, leaving him to find savings or tax rises of roughly £11bn to restore room for anything new. The government has little choice: Britain's debt stands near 94% of GDP, and its fiscal rule requires that ratio to fall. Even before setting policy, the state is being charged more to finance the debt it has.

The market is not pleading with Britain to default. The auction, after all, was filled about twenty times over, in a striking contrast to 2022, when leveraged pension funds were forced sellers and the Bank had to stand behind the market. The trouble is subtler: Britain can be financed, but only at a price that now flows straight into every budget forecast. That is why long-dated conventional gilts are set to make up less than a tenth of the £246bn of issuance planned for the year — an admission, in the menu of what the state offers, that the long end has become too dear to sell in volume. And Britain sits near the top of the developed world's borrowing-cost league table, second among G10 governments only to Australia.

For an investor the lesson is not to bet on a British default, a position the evidence does not support. It is to see the change in the structure of the market. Britain's yields are a leading example of a global repricing of long-duration risk at a moment when governments everywhere must borrow more and the natural buyers of their debt are thinning out. In that repricing, fiscal rules do the state no favours: by forcing the chancellor to consolidate just as borrowing costs rise, they risk crushing the growth that would bring the debt-to-GDP ratio down. The market will keep lending to Britain. The question is whether the price it now demands leaves the treasury room to govern.