Borrowing costs jump to Truss-era levels as inflation shock fuels fears of rate hikes

GOVeRNMeNT borrowing costs soared to Liz Truss-era levels yesterday as mounting concerns about inflation set the scene for yet more interest rate rises.

Official figures showed inflation in the UK fell to 8.7pc in April, from 10.1pc in March and a peak of 11.1pc last year.

But it was still above the 8.2pc pencilled in by investors, and so-called ‘core’ inflation – which strips out energy prices – jumped from 6.2pc to a 31-year high of 6.8pc. The report from the Office for National Statistics sent tremors through the bond markets as investors bet that interest rates could hit 5.5pc this year – far higher than previously thought.

Two-year gilt yields, a key measure of Government borrowing costs, jumped to 4.39pc – the highest level since the turmoil that followed the disastrous miniafford Budget of Truss and Kwasi Kwarteng last year. The yield was around 3.2pc just two months ago and yesterday’s rise was also the biggest since the Truss-Kwarteng debacle. Five-year and ten-year gilt yields also jumped to their highest levels since October at over 4pc, while the pound made gains against the dollar and the euro before easing.

Rob Clarry, investment strategist at wealth manager evelyn Partners, said the reaction on the bond markets was ‘instant’ as traders bet on further rate hikes – dashing hopes that borrowing costs were at or close to their peak.

Bond yields surged under Truss as global markets fretted over how Britain could her plans to cut taxes and help households with energy bills. The turmoil sent the cost of mortgages and other loans soaring. But, having fallen under Truss’s successor Rishi Sunak and Jeremy hunt – Kwarteng’s replacement as Chancellor – borrowing costs are rising again.

The Bank of england has already raised interest rates 12 times since December 2021, taking them from 0.1pc to 4.5pc.

It was hoped that rates were not at or close to a peak. But with inflation higher than feared, investors now see a 100pc chance that rates will rise to at least 4.75pc in June. Further hikes to 5pc in August and possibly as high as 5.5pc later in the year are also on the cards.

‘Bond markets took one look at the latest inflation figures and took the view that interest rates are going to keep going up,’ said Russ Mould, investment director at AJ Bell. ‘Sticky inflationary pressures, particularly in food, will strengthen the argument for the Bank of england to raise rates again.

‘That will bring more pain to companies and consumers as the cost of servicing borrowings becomes more expensive.’

The pound rose back towards $1.25 and €1.16 before giving up its gains following a strong run so far this year.

‘The reason that you haven’t seen more of a reaction today is the context,’ said Ben Laidler, global markets strategist at trading platform eToro. ‘The pound’s already had a big rally this year.’

he added that growing concerns about the health of the global economy were boosting the dollar, which is often seen as a safe asset in times of strife.