UK 10-Year Borrowing Costs Hit 5.13% Amid Leadership Change Fears

The effective interest rate on UK borrowing over 10 years briefly hit 5.13%, levels not seen since the 2008 global financial crisis.

Financial markets stayed on edge over fears that higher oil prices from the Iran war would drive up inflation and prompt interest rate hikes. A possible change of leadership in the UK, along with perceived risks of looser public spending, added to investor unease.

The FTSE 100, the UK's main stock index, fell 0.5%. Shares in British banks led the declines on concerns about a tax raid from a potential new administration. The pound dropped 0.5% against the dollar to $1.35.

All governments faced higher borrowing costs since the Iran war pushed oil prices above $100 a barrel. The UK saw elevated rates compared to countries with similar-sized economies.

Analysts said investors worried that potential replacements for Prime Minister Sir Keir Starmer might loosen public spending and increase government borrowing.

Starmer and Chancellor Rachel Reeves have stuck to "iron clad" borrowing rules to assure markets of their economic plans' credibility.

Some Labour MPs on the party's left questioned whether the UK's budget rules were "fit for long-term renewal".

Capital Economics analysts predicted UK borrowing costs would rise and the pound would weaken if Labour saw a leadership change at the top. "The UK's already fragile fiscal position means that investors will be on edge for any signs of fiscal loosening," they said. "The likely replacements for Starmer/Reeves would probably not be as fiscally disciplined."

Anna Macdonald, investment strategy director at Hargreaves Lansdown, said the bond market had been "frazzled" by concerns a different prime minister might relax fiscal rules or extend them. "This would mean that investors, of which 25-30% are overseas buyers of UK government bonds, demand a higher risk premium," she added.

Governments rely mostly on taxes for income but often spend more than taxes bring in. They borrow to cover the gap by issuing bonds or gilts, loans they promise to repay after an agreed period.

Investors want certainty and confidence of a return when lending to governments. On Tuesday, borrowing costs across two-, five-, 10- and 30-year terms all rose as the prime minister's future looked shaky. The 30-year bond yield hit 5.80%, the highest since 1998.