The UK’s long-standing “risk premium” in financial markets appears to be dissolving as economists claim investors are regaining confidence in Rachel Reeves’ financial strategy – and that the change could save taxpayers billions of pounds over the next five years.
New analysis from the Institute for Public Policy Research (IPPR), a think tank with long-standing ties to the Labor Party, shows government bond yields have fallen faster than those in the US and the euro zone since September. The move follows a turbulent year in which borrowing costs in the UK rose significantly higher than other G7 economies, fueled by persistent inflation, weak growth and speculation about the new government’s tax plans.
According to the IPPR, British government bond yields have fallen 0.2 percentage points more than their American and Eurozone counterparts in recent months. The reversal, while modest, is seen as a significant sign that Reeves’ public endorsement of tough fiscal rules, first reiterated at the Labor conference, has calmed financial market jitters since Liz Truss’ mini-Budget in 2022.
At the start of the year, the gap between UK and US 10-year bond yields had shrunk to 1.1 percentage points; The margin was 0.6 points compared to the debt of the Eurozone. For 30-year bonds, the divergence was even greater, reaching 1.5 points versus US Treasuries. These differences amounted to a clear “risk premium,” a financial penalty imposed on the UK because of political unpredictability and concerns about fiscal credibility.
“The reasons for this premium are not clear, particularly given that the UK’s fundamentals are stronger than those of many countries with lower borrowing costs,” the IPPR noted, pointing to the UK’s debt-to-GDP ratio, which is around 100%, lower than the US, Italy or Japan.
Senior Bank of England officials echoed that assessment. Deputy Governor Sir Dave Ramsden told MPs on the Finance Committee that government bond market volatility in the run-up to Reeves’ budget was noticeably lower than in comparable pre-budget periods under the previous Conservative government.
“There were no concerns about financial stability,” he said, a stark contrast to the gilt market crisis triggered by the unfunded Truss tax cuts.
The bank now expects next year’s budget to cut inflation by up to 0.5 percentage points, largely thanks to Reeves’ decision to remove taxes from household energy bills. Inflation is currently at 3.6%.
Despite the recent improvement, borrowing costs in the UK remain high by historical standards and are still higher than those in the US or eurozone member states. The Office for Budget Responsibility predicts that debt interest payments will exceed £100 billion in each year of this parliament.
However, if the remaining risk premium were removed, taxpayers could save up to £7 billion a year by 2029-30, according to IPPR, money that could otherwise be used for public services or debt reduction.
Carsten Jung, deputy director of economic policy at the IPPR, said a “clear, credible” fiscal stance could make the UK “a leader in the G7”, but warned that the Bank of England could undermine progress if it continues its aggressive program of quantitative tightening.
The bank estimates that its bond sales have pushed up British government bond yields by up to 0.25 percentage points. Jung said the bank should “do its part” and pause sales to avoid unnecessarily driving up borrowing costs while the government tries to restore stability.
Bond yields have also been kept higher by falling demand from pension schemes, which were once major institutional buyers of long-dated government bonds.
But for now the message from markets appears clearer than it has been in years: after 18 volatile months, investors may finally believe that Britain has rediscovered its fiscal discipline.
