Andy Burnham, an insurgent British politician who wants to be the next prime minister, has begun his campaign focused not only on voters but also on the bond market.
The reason? Britain’s creditors balked after Mr. Burnham, the mayor of Greater Manchester, made clear on Friday that he would grasp for 10 Downing Street. Last year, he said that the government should not be “in hock to” the bond market when deciding how to spend money. That comment was not forgotten.
In the past few days, he has tried to quell the fears about his financial credentials, vowing to bring Britain’s debt down and stick to fiscal rules.
But that wasn’t before investors dumped British government bonds, known as gilts, pushing down their prices and driving up their yields, in some cases to levels not seen since the 2008 financial crisis. The timing of Mr. Burnham’s run was unfortunate: The market for gilts was already on high alert, alarmed that the war in Iran was stoking inflation, which eats into the value of bonds.
Even as yields have also been rising in other countries, including Japan and the United States, the political fallout in Britain has been the most acute. That’s in part because the British government has been here before. Mr. Burnham’s challenge set off reminders of Liz Truss’s 49-day premiership in 2022, when financial markets recoiled at a financial plan heavy on tax cuts, paid for by more borrowing.
Ms. Truss was one of five prime ministers to pass through the revolving door of leadership in the past decade, and Keir Starmer could be next in the coming months. So the British government’s fraught relationship with its creditors is again squarely on the public agenda as yet another leadership contest brews.
The nation’s political and business communities are seized by a growing sense that the bond market has become an unofficial — and unelected — judge ready to punish leaders who are deemed to have stepped out of line on fiscal policy.
Who is the bond market, anyway?
Britain spends more money than it brings in through taxes, and it borrows to make up the shortfall. The more it borrows, especially at higher rates, the more it must spend paying interest on the debt. If the economy isn’t growing firmly, that leaves less money for public services and other investments. In the last financial year, the British government devoted about 8 percent of its total spending to interest payments.
Britain has about 2.9 trillion pounds ($3.9 trillion) in debt, about 93 percent of the size of economy. The debt burden has grown sharply: Much of that debt started piling up during the financial crisis two decades ago, before which debt was 34 percent of gross domestic product.
For a long time, Britain has relied on what a former central bank governor called “the kindness of strangers.”
About a third of British government bonds are held by overseas investors, including Japanese pension funds and American asset managers. The rest are held by British funds, investors and the Bank of England, the central bank.
That pool of investors has shifted drastically. The share of gilts held by domestic pension funds and insurance companies has shrunk noticeably over the past six years. At the same time, the Bank of England has reduced its holdings, from about a third of all outstanding gilts in 2022 to less than 20 percent.
In place of these patient and conservative buyers, who would hold gilts for a long time, hedge funds and other financial institutions have expanded their place in the market. Private investment firms buy and sell the debt more quickly, seeking to make money on small changes in yields. More trading brings more volatility and can push up yields at times of stress.
Now, Britain has become increasingly reliant on the kindness of price-sensitive investors.
“It doesn’t raise the overall level of yields,” said Michael Saunders, a former official at the Bank of England who helped set interest rate policy. “But it probably makes gilts more sensitive to shocks.”
What do these investors care about?
Britain’s borrowing costs have surged this year, outpacing its peers, such as the United States, Germany and Italy. The yield on 10-year benchmark bonds climbed above 5 percent to their highest levels since 2008, while the yield on 30-year debt was the highest since 1998.
The big driver of the higher yields is the outlook for inflation, said Mr. Saunders, who counts political uncertainty and the bigger role of hedge funds as “secondary factors.”
Before the war in the Middle East began, investors believed that the Bank of England was on the cusp of cutting interest rates. Instead, the effective closure of the Strait of Hormuz, a crucial Persian Gulf shipping channel, led to a spike in energy prices. That quickly fed inflation in Britain. Investors changed their view and started betting that the central bank would raise rates.
Inflation in Britain was already higher than in some other European countries, setting a higher floor for bond yields, and the domestic political uncertainty has increased the chances of more government borrowing.
It’s not just Britain.
While the bond market is making the front pages in Britain, these are global challenges.
Many governments have borrowed more in recent years, to fund emergency responses to the Covid-19 pandemic and the 2022 energy shock after Russia’s full-scale invasion of Ukraine, and are under pressure to do so again as the war in the Middle East drags on. But this time, central banks aren’t buying huge swaths of government debt and easing pressure on borrowing costs. That leaves hedge funds and other investment funds as bigger buyers in the debt markets of many advanced economies.
There are also rising expectations for inflation globally. In the United States, longer-term bond yields hit highs last seen in 2007. Japan’s 10-year yields were the highest in about three decades.
In fact, the sell-off in the Japanese bond market this year has been worse than the one in Britain. Japan’s heavy debt burden — more than 200 percent of its G.D.P. — could grow as the government tries to shield its economy from the war in the Middle East.
In the short term, though, the higher inflation outlook will be difficult to avoid around the world. Including in Britain, regardless of who the prime minister is.
Experts say British politicians must acknowledge that investors are paying close attention to the country’s economic outlook and to whether lawmakers follow through on the plans they make.
Investors aren’t on the verge of dumping British assets in a major way, said Ed Al-Hussainy, a portfolio manager at Columbia Threadneedle, an investment firm that holds gilts. One reason: the higher yields mean gilts are offering better returns for investors. But in “a global environment in which interest rates are going up,” he said, “the U.K.’s quirks around fiscal policy and the U.K.’s disadvantages when it comes to the growth” mean it is being “disproportionately punished by investors.”
Eshe Nelson is a Times reporter based in London, covering economics and business news.
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