Borrowing costs have reached their highest level in two months, with 10-year gilt yields climbing back above 5 percent for the first time since May. This increase is attributed to the resumption of hostilities in the Middle East, which has driven oil prices to their highest point in nearly a month, with Brent crude surpassing $86 a barrel.
Ten-year gilt yields rose 0.06 percentage points to 5.03 percent on Monday morning, although they have since fallen slightly to trade around 5.01 percent. The longer-dated 30-year yields are up three basis points at 5.7 percent. In May, 10-year gilt yields had reached 5.2 percent, a level not seen since 2008.
The renewed conflict follows U.S. strikes against Iran for the third consecutive night. President Donald Trump has signaled the possibility of reinstating a blockade of the Strait of Hormuz and has proposed a 20 percent fee for guarding the vital waterway.
Bank of England Governor Andrew Bailey stated that the escalating conflict has increased risks to financial stability. "I don't certainly feel qualified to judge how long this is going to go on for in terms of this resumption of hostilities and how it's going to end," Bailey told the Treasury Select Committee. "But it underlines that this is going to be an unstable process for the foreseeable future."
The heightened risk of further inflation has prompted investors to anticipate two interest rate hikes this year, driven by the threat of elevated energy prices. These higher borrowing costs are expected to place pressure on the incoming Prime Minister, Andy Burnham, who is set to take office next Monday. Susannah Streeter, chief investment strategist at Wealth Club, noted that "Mr. Burnham will inherit one of the toughest fiscal challenges of any incoming Prime Minister in decades." She added that meeting priorities such as repairing public finances, funding public services, and stimulating economic growth "is likely to require higher taxes."
Investors have expressed concerns about the potential direction of Burnham's government, with some anticipating a shift that could unnerve financial markets. While reactions to Burnham's campaign have been generally muted, his choice of Chancellor could potentially lead to further sales of UK government bonds. Asset manager Rathbones has reportedly reduced its holdings of UK gilts as a protective measure against "fiscal irresponsibility."