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The UK economy could be plunged into a recession an “order of magnitude” greater than recent financial crises if America’s borrowing costs continue to climb over the rest of the year, a group of leading City analysts have warned.
The US was forced to pay the highest interest rate on its long-dated bonds for a quarter of a century on Thursday, amid growing concerns over the country’s gaping deficit and stickier-than-expected inflationary pressure.
Investors demanded yields as high as 5.22 per cent at the $25bn auction of 30-year Treasuries, according to the US Treasury department. The sale represented the highest borrowing cost rate since August 2001 and was substantially more elevated than the auction of 30-year bonds that took place just before the beginning of Donald Trump’s second term.
The auction has reignited fears that the US’s increasingly expansionary fiscal policy could trigger a government debt crisis on a scale not seen in recent history in which investors flee the the US bond market for rival safe havens like gold.
Any sharp repricing of US Treasuries would have enormous repercussions for the global economy, with shockwaves likely across markets with high debt-to-gross domestic product (GDP) ratios like the UK.
Roger Lee, head of equity strategy at Cavendish, said that knock-on effects of a Treasury market rout would be “very bad” for the UK, with higher mortgages and corporate debt interest strangling the already stagnant economy.
“A recession either as a result of first order effects of increased debt servicing costs or a fiscal consolidation forced by a gilts crisis would be likely,” he told City AM, adding: “The economic pain in peripheral Europe and Asia during their debt crises was profound.”
The US’s spiralling borrowing costs follow the country’s debt pile swelling to a record $40 trillion, roughly double levels from just a decade ago.
Treasury market has ‘knock-on effect’ for UK economy
The country’s deficit – the difference between the amount a government receives in tax and issues via state spending – has climbed dramatically since Trump took office. The President announced a set of sweeping tax cuts that his flagship Elon Musk-run Department of Government Efficiency were unable to recoup through reducing state spending.
“If fresh US bond auctions require higher and higher yields and lower and lower prices, there is the possibility the system will get clogged up,” said Helen Thomas, chief executive of Blonde Money. “That wouldn’t just be a problem many magnitudes larger than the UK gilt crisis – it would have a knock-on effect to all financial markets.”
Until recently, UK concerns over a government debt meltdown had been largely restricted to the country’s domestic gilt market. UK coupons have been coming under pressure thanks to a combination of Britain’s exposure to inflation and its protracted political uncertainty.
But the United States’ stranglehold over global markets means that any sudden sell-off in its debt would course through the wider financial system. The rout would not only dent the UK economy’s growth prospects but would also force the government to pay more for its debt, putting further pressure on the country’s already precarious public finances, Lee said.
James Sproule, chief economist at Handelsbanken, told City AM that the passage of events should force Chancellor John Healey to exercise “even more caution” at his maiden Budget on 28 October.
“Healey will have to meet both the letter and the spirit of the ‘golden rules’,” he said. “Resist altering debt calculations, have debt to GDP falling by a per cent or more, show that we are moving rapidly down Reeves’ planned deficit reduction pathway.”