UK Fiscal Vulnerability and the Rising Cost of Debt

The United Kingdom’s fiscal position has reached a critical juncture. Public sector net debt now stands at 96.1% of GDP, a level last seen in the early 1960s, with the deficit in the financial year to June 2025 reaching £44.5 billion—a £6.5 billion increase compared to the same period in 2024 [1]. These figures underscore a systemic challenge: the UK’s debt-to-GDP ratio remains among the highest in advanced economies, while rising interest costs are eroding fiscal flexibility. In July 2025 alone, the government paid £7.1 billion in interest on its debt, a £0.2 billion rise from the previous year [3]. Such trends are not merely statistical; they signal a deepening vulnerability that could reverberate through the autumn budget and beyond.

Bond markets have already begun to price in this risk. The yield on UK 10-year government bonds surged to 4.75% in late August 2025, while 30-year yields hit a 27-year high of 5.72% [2]. These levels reflect investor concerns about the sustainability of the UK’s fiscal strategy. The pound, too, has suffered, dropping over 1.5% against the US dollar in early September—a stark reminder of the currency’s sensitivity to fiscal uncertainty [4]. The Office for Budget Responsibility (OBR) has warned that borrowing costs are now 3% of GDP higher than what is necessary for durable debt stabilization, a gap that could widen without credible fiscal reforms [5].

The political economy adds further complexity. Chancellor Rachel Reeves’s autumn budget, announced in November 2025, has introduced aggressive measures to address a £41.2 billion deficit, including reforms to inheritance tax, capital gains tax, and property taxes [1]. While these steps aim to reduce inequality and fund public services, they risk alienating high-net-worth individuals and wealth management sectors. Critics argue that such policies could reduce liquidity in private equity and real estate markets, compounding economic fragilities [1]. The OBR has also highlighted significant uncertainties in fiscal forecasts, particularly around welfare and employment support policies, which lack sufficient cost analysis [3].

Credit rating agencies, however, remain cautiously optimistic. Morningstar DBRS has affirmed the UK’s credit rating at AA with a stable outlook, citing a “balanced view of risks” amid economic recovery [5]. Yet this stability is conditional. The International Monetary Fund (IMF) has noted that the UK’s fiscal strategy hinges on navigating global uncertainties and volatile financial conditions [4]. With public sector net borrowing still elevated and debt at historic levels, the margin for error is slim.

The autumn budget must therefore strike a delicate balance. On one hand, it must reassure bond markets that fiscal discipline is being restored. On the other, it must address structural weaknesses in the economy without triggering a backlash from key economic actors. The challenge lies in aligning short-term deficit reduction with long-term growth. As the OBR’s Fiscal Risks and Sustainability report emphasizes, the UK’s debt and deficit levels remain among the highest in the advanced world, and rising borrowing costs could further constrain fiscal flexibility [3].

For investors, the implications are clear. The UK’s fiscal trajectory is increasingly dependent on the credibility of its policy framework. A failure to stabilize debt dynamics could lead to sharper bond yield spikes, currency depreciation, and a loss of confidence in the pound-denominated asset class. Conversely, a well-calibrated budget that addresses both immediate deficits and structural vulnerabilities could restore market calm. The coming months will test the government’s ability to navigate these risks—a test with profound consequences for the UK’s economic future.

Source:[1] Public sector finances, UK: June 2025 [https://www.ons.gov.uk/economy/governmentpublicsectorandtaxes/publicsectorfinance/bulletins/publicsectorfinances/june2025][2] UK long-term borrowing costs hit 27-year high, and pound ... [https://www.theguardian.com/business/live/2025/sep/02/uk-long-term-borrowing-costs-27-year-high-gold-silver-inflation-business-live-news-updates?page=with%3Ablock-68b6c35c8f08843adc109f70][3] Fiscal risks and sustainability – July 2025 [https://obr.uk/frs/fiscal-risks-and-sustainability-july-2025/][4] Staff Concluding Statement of the 2025 Article IV Mission [https://www.imf.org/en/News/Articles/2025/05/27/cs-uk-aiv-2025][5] Morningstar DBRS Confirms the United Kingdom at AA ... [https://dbrs.morningstar.com/research/454227]