Why Are UK Borrowing Costs So High?
Summary
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Panellists primarily attributed high UK borrowing costs to a combination of inflation expectations and concerns about fiscal sustainability: 71% of panellists thought that higher inflation expectations relative to the G7 have contributed to elevated UK borrowing costs. 68% believed that borrowing costs reflect concerns over UK public debt sustainability.
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Respondents were evenly split on the role of borrowing costs in the upcoming Budget: 48% of panellists thought that borrowing costs should be one of the main factors shaping the fiscal stance. 48% believed they should play a secondary role. 3% said that borrowing costs should play little or no role.
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Question 1: What are the main factors that explain why UK government borrowing costs (10-year gilt yields) are the highest in the G7?
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Thirty-one panellists responded to this question. The survey allowed panellists to choose up to three options and the percentages reflect the share of the panel that choose each option. A majority of panellists considered inflation expectations relative to G7 peers (71%) and concerns over fiscal sustainability (68%) to be main factors contributing to the UK’s high borrowing costs. Around 35% of the panel saw the growth outlook and r* as a driving factor, while fewer respondents highlighted spillovers from US yields (26%), composition and depth of the gilt investor base (19%) and quantitative tightening (10%).
Eighteen of the thirty-one respondents provided additional commentary to their answer. Those who pointed to inflation expectations as a main factor generally cited the persistence of inflation in the UK relative to its G7 peers. Michael Wickens (University of York) stated that the market has priced-in continued “ineffectiveness” of UK monetary policy and therefore higher inflation, arguing that the current monetary policy framework is designed to deal with demand shocks and that UK inflation is currently driven by supply-side factors.
Panellists reported that concerns about UK public debt sustainability reflect the inability of successive governments to cut spending and a loss of credibility following the 2022 mini-budget. Ricardo Reis (LSE) highlighted a “political inability to meaningfully cut spending (e.g., triple-lock) or raise tax rates on activities with large tax bases (e.g., property or income for lower-middle-class)”. Charles Bean (LSE) echoed these sentiments, stating that higher long-end yields reflect “the unwillingness of successive UK governments to recognise the realities of the country's economic and fiscal position and their consequent inability to push through an effective policy response”. Andrea Ferrero (University of Oxford) thought that concerns over debt sustainability were partly contributing to borrowing costs, but that these concerns are “misguided” and may reflect a loss of credibility following the mini-budget. Robert Kollman (Université Libre de Bruxelles) also cited “lingering” credibility concerns following the mini-budget as well as the UK’s “outsized financial sector” which he argued heightened fiscal risks relative to other advanced economies.
A number of panellists highlighted the UK’s subdued growth outlook relative to r*. Jagjit Chadha (University of Cambridge) noted that successive governments have reversed plans to reduce spending and raise taxes, concluding that “it is hard to see with our low levels of projected growth how we can stabilise or even better consolidate our fiscal position”. Lucio Sarno (University of Cambridge) said that markets are “now pricing in fully the long-term negative growth effect of Brexit” while Matthias Doepke (LSE) highlighted the “anaemic” growth outlook due to a “lack of meaningful reforms since the Brexit shock”.
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Question 2: How much should the high level of UK government borrowing costs play a role in shaping the fiscal stance in the next Budget?
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Thirty-one panellists responded to this question. Just under half (48%) of the panel thought that borrowing costs should be one of the main factors shaping fiscal stance in the upcoming Budget, while an equal share (48%) believed they should play a secondary role alongside other priorities. One respondent thought that borrowing costs should play little or no role in the next Budget. Zero respondents believed that borrowing costs should be the decisive factor in shaping the fiscal stance.
Sixteen of the thirty-one respondents provided additional commentary to their answer. Panellists who thought borrowing costs should be one of the main factors shaping the fiscal stance placed greater weight on maintaining market confidence and reducing government expenditure. Charles Bean (LSE) said that “the government really cannot afford to see yields on its debt rise substantially more”, arguing that it is “crucial” to maintain the confidence of market participants. Jagjit Chadha (University of Cambridge) argued that “we urgently need the state to be trimmed which would leave space for public investment rather than meeting ever higher levels of public expenditure with increases in taxation”. Roger Farmer (University of Warwick) stated that “getting fiscal profligacy under control should be primary focus of the budget” and that “the UK is currently on the path of an unsustainable trajectory that calls for reductions in the size of the welfare state”.
Those who proposed that borrowing costs should play a secondary role placed greater emphasis on policymaking that targets productivity and economic growth. Lukasz Rachel (University College London) thought that “the government would be given more slack by the market if the borrowing was funding valuable assets such as human, social and infrastructure capital. Growth is the best way to balance the books in the longer-term”. In a similar vein, Nicholas Oulton (LSE) argued that raising the rate of productivity growth would improve fiscal sustainability, highlighting the need for a “combination of higher public investment in infrastructure and skills but above all improved incentives for private investment, via planning reform and tax policy”. Ethan Ilzetzki (LSE) noted that “excessive” focus on the deficit has led to “erratic and ill-advised” policies, while Federica Romei (University of Oxford) argued that focusing only on borrowing costs would make it “difficult to implement reform that can hopefully boost growth”.
Please note: for the confidence-weighted graphs, each panellist’s response is assigned a weight based on their self-reported confidence (rated from 1 to 10, where 10 indicates maximum confidence). This weight is calculated as the individual’s confidence score divided by the sum of all respondents’ confidence scores. Panellists who did not provide an answer are excluded from this calculation.