Bill Gross once warned that UK government bonds were “resting on a bed of nitro-glycerine”. He may have been early rather than wrong.
After years of low inflation and central bank support sent gilt prices soaring, the market is again under scrutiny as investors brace for next month’s Budget.
Panmure Liberum has flagged that the UK is paying a hefty premium to borrow compared with other major economies, with 10-year gilt yields around half a percentage point higher than those of any G7 peer.
Across all maturities, the gap is more than one percentage point above the G7 median. That has revived talk of a so-called “moron premium”, a phrase born during the Truss-Kwarteng era, and its possible replacement, the “dullness dividend”, earned under Rishi Sunak and Jeremy Hunt.
Fiscal headroom
Panmure's chief economist, Simon French, estimates that closing the spread could free up as much as £18 billion of fiscal headroom by the end of the decade, nearly double the current allowance.
But that would require credible policy moves to convince investors that the UK can keep inflation and long-term debt in check.
At the short end of the gilt curve, two-year yields hover near 4%, about 45 basis points higher than the next most expensive G7 borrower.
That reflects market concern that British inflation, still above peers, will persist. Panmure points to wage policy and energy supply as the main culprits.
It argues that linking the national living wage to 66% of median earnings bakes in future price pressure, while restrictions on North Sea oil and gas licensing add to costs. Reversing both, it says, could anchor expectations and allow borrowing costs to ease.
Further out, the problem is different
Further out on the curve, the problems look different. Thirty-year yields sit about 70 basis points above the G7 average, even though near-term debt and deficit forecasts compare favourably with other economies.
The bigger worry is structural: an ageing population, pension costs and a shrinking base of long-term buyers. Defined benefit pension schemes, once large gilt holders, are running down their assets, while new issuance has tilted towards shorter maturities.
Panmure suggests a few levers to help. Ministers could clarify the future of the state pension triple lock, reassuring investors that it remains affordable.
Another option would be to promote demand through new vehicles, such as sterling or gilt-backed digital currencies, to mirror the liquidity benefits the US Treasury has found through its stablecoin experiments.
Aggressive sales
Finally, the Bank of England’s aggressive bond sales have not gone unnoticed. While the Federal Reserve and European Central Bank have slowed balance sheet reduction, the Bank continues to shrink its holdings, on track to reach pre-pandemic levels by 2026.
Panmure thinks the timing is no coincidence: fewer official buyers have meant wider gilt spreads.
With the Budget looming, the question for Rachel Reeves is whether to act early and calm the market, or risk a harsher verdict later if borrowing costs spike again. Investors, it seems, have little patience left for fiscal fireworks.