UK: Rising debt costs and fiscal uncertainty

[Ben Graham]

• UK gilt yields may rise toward 6%, reflecting mounting fiscal strain and investor concerns
• Persistent outflows from UK equity funds signal weak confidence despite temporary market calm
• Commodities and mining stocks support the FTSE, contrasting with broader economic instability

The British economy is facing serious fiscal challenges that are increasing tensions in the bond market and may affect the pound’s exchange rate. Despite the government’s declarations about maintaining budget balance, experts warn that the tax increases announced by Chancellor Rachel Reeves are too dispersed to meaningfully strengthen public finances and ease pressure on debt markets.

A prospect of 6% yields

David Zahn of Franklin Templeton forecasts that the yield on 30-year UK government bonds could reach 6%, highlighting the government’s difficulties in financing rising expenditures. The current spread between UK and German bonds of the same maturity stands at 176 basis points, and 78 basis points relative to France, placing the UK among the most expensive developed countries in which to borrow.

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Yield on 30-year UK bonds and spread between UK, German, and French bonds, source: TradingView

Zahn, who sold all his UK bonds back in March, believes that only a further rise in debt-servicing costs will force the government into genuine fiscal adjustment. As he puts it: “Eventually yields will be so high that the government won’t be able to sweep the problem under the carpet any longer.”

Questionable revenue and political risk

Although Reeves has pledged to increase the “fiscal buffer” and avoided the most controversial tax hikes (such as taxes on pension withdrawals or capital gains), rating agencies and think tanks doubt the long-term stability of the plan.

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Fund Flow Index, source: Calastone

November also saw the second-worst outflow from UK equity funds in history—investors withdrew £3 billion, reflecting market tensions ahead of the budget announcement. Only after the budget was published did the outflows stop, suggesting investors feared radical changes that ultimately were not introduced.

GBP: Short-term relief, long-term risks

The pound has recently appreciated against a weakening dollar, and the bond market calmed after the budget release. However, by the end of the European session, GBP/USD met resistance at the 200-period SMA, which also aligns with the 50% Fibonacci retracement of the decline seen between September and November this year. Structural issues within the UK economy—high debt levels, low growth, and weak investment sentiment—remain unresolved.

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Daily timeframe of GBPUSD, source: TradingView

Meanwhile, investors continue to avoid UK funds—only one month out of the last 55 saw a net inflow of capital. The government is attempting to stimulate the market through measures such as tax incentives for new listed companies and changes to the ISA system to encourage equity investment.

Strong commodities and decorrelation in the energy market

Against the backdrop of fiscal problems, the commodities sector remains the one bright spot in the UK market—copper and gold prices are hitting records, supporting mining companies’ valuations. The FTSE 100 owes much of its strength to the rising weight of mining stocks in the index.

The energy sector (FTSE 350 Energy) has also seen gains recently despite falling oil prices, likely driven by high dividends and share buyback programmes. However, investors should be aware that valuations may not hold if the geopolitical situation improves—for instance, if peace is achieved in Ukraine. Today the index recorded losses of more than 1.76%.

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FTSE 350 Energy index compared to Brent crude prices, source: TradingView

The UK is at a turning point. A relatively strong currency and buoyant commodities sector contrast sharply with deep concerns over the stability of public finances. The prospect of rising bond yields and tax uncertainty may, in the coming months, once again increase the government’s financing costs and weaken investor confidence in the pound and UK assets.

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