Bond markets were thrown into chaos on Thursday, threatening a new mortgage shock for homeowners amid fears that the Bank of England has lost control of inflation.
Britain's borrowing costs rose to the highest in the G7 for the first time since the financial crisis as Legal & General, one of the City's most powerful asset managers, said it had stopped making long-term investments in the UK debt market because of economic uncertainty.
The turmoil triggered an immediate response from lenders, with Nationwide, Britain’s biggest building society, raising rates by up to 0.45 percentage points across its mortgage range.
Market ructions, caused by fears that inflation is remaining stubbornly high, have sent borrowing costs surging back to levels last reached during then-prime minister Liz Truss’s “mini-Budget” crisis.
Sonja Laud, chief investment officer at Legal & General Investment Management, said: “The inflation data that we got yesterday in the UK will put a lot of pressure on the Bank of England in getting this balancing act right.
“There are inflationary pressures [in the UK] that clearly are still higher than what we see elsewhere in Europe or the US.
“We are looking more tactically at gilts because with the volatility at hand there are opportunities. But we are not engaging in the longer term, simply because of the lack of a clearer narrative.”
The yield on ten-year debt rose by almost 0.2 percentage points on Thursday to 4.37pc, putting it above Italy's rate of 4.35pc.
It is the first time British yields have topped the G7 group of advanced economies since the dawn of the financial crisis in 2007. Even at the height of last year's mini-budget turmoil, Italy's borrowing costs were still above Britain's.
The increase is a significant challenge to the credibility of the Chancellor Jeremy Hunt and Andrew Bailey, Governor of the Bank, who sought to present themselves as competent economic managers after the chaos of Ms Truss's brief premiership.
It comes after markets were spooked by unexpectedly strong inflation data on Wednesday showing that prices rose by 8.7pc last month, significantly more than the Bank's expectations of an 8.4pc increase. Britain's inflation rate is comfortably the highest in the G7 and there are increasing concerns that it is being driven by wage growth rather than external shocks, making it even harder to contain.
Traders now expect interest rates to rise to 5.5pc by the end of the year, up from 4.5pc at present.
Rates in the swap market, which is used to price mortgages, have jumped as a result, forcing lenders to respond.
Lloyds, Virgin Money and Halifax all announced small mortgage rate rises on Thursday, with more big lenders expected to do the same in the coming days.
Gary Greenwood, a banking analyst at Shore Capital, said: “Other banks will need to follow suit if swap rates stay at their new level, which will push up the cost of borrowing for homeowners that have mortgages and so squeeze household finance.”
Virgin Money increased its rates by up to 0.12 percentage points, while Lloyds and Halifax increased rates by up to 0.2 points.
Nationwide said it was increasing rates across its new business, additional borrowing, switcher and existing customer moving home ranges. The 0.45 percentage point increase will add around £60 a month to the cost of a typical £250,000 mortgage.
A Nationwide spokesman said: “In the current economic environment, swap rates have continued to fluctuate and, more recently, increase, leading to rate rises across the market. This change will ensure our mortgage rates remain sustainable.”
Britain’s ten-year borrowing costs were the fourth lowest in the G7 at 0.4pc when Covid struck in March 2020.
During the mini-budget crisis last year, 10-year gilt yields rocketed to 4.5pc as investors bet that Ms Truss’s policies would be inflationary, putting Britain second behind Italy.
Commentators claimed that the UK was suffering a “moron premium” as investors demanded extra money in return for its political and economic instability.
Mr Hunt later scrapped almost all of the mini-budget reforms after replacing Kwasi Kwarteng as Chancellor, and reassured markets by vowing to take “difficult decisions” on spending.
Borrowing costs fell to just above 3pc when Ms Truss lost power.
However, they have crept up again in subsequent months after the Bank of England proved far too gloomy on economic growth and predicted that inflation would fall much more quickly than it has.
The latest turmoil could threaten to damage Prime Minister Rishi Sunak’s reputation for sound economic management.
In November, Mr Sunak said “mistakes were made” by Ms Truss and he vowed to make “difficult decisions that are required to fix” her missteps.
Speaking in Washington on Thursday, Jonathan Haskel, an external member of the Bank of England’s Monetary Policy Committee, said: “Further increase in Bank Rate cannot be ruled out.”
“Inflation could persist well beyond the terms of trade shock if dynamics in labour and capital income become embedded.”
He added: “Early signs of loosening in the labour market have not been enough to dispel this risk.
“I view it as still very tight in an absolute sense. The vacancy to unemployment ratio and unit wage growth are both historically high.”