UK borrowing costs have risen to levels not seen in nearly three decades, increasing pressure on government finances and raising questions about whether the gilt sell-off is spreading into equities.
With long-term gilt yields approaching 6%, investors are now watching the FTSE 100, FTSE 250 and British pound for signs that tighter financial conditions are becoming a broader market problem.
The pressure begins with competition for investor capital. Government bonds offering yields near 6% provide higher income without the corporate risks attached to equities. That shift has already reduced one traditional attraction of UK blue-chip stocks. The FTSE 100’s dividend yield relative to gilts has fallen to its lowest level in 19 years as government bond returns have risen.
Higher yields can also weigh on company valuations by increasing the discount rate applied to future earnings. That creates additional pressure for rate-sensitive companies and businesses that depend heavily on borrowing or refinancing.
The equity market has begun showing signs of strain. During the recent bond sell-off, the FTSE 100 fell by 0.3% to 10,789.28, while the FTSE 250 dropped by 1.7%.
The divergence between the two indexes offers an important signal. The FTSE 100 generates much of its revenue overseas, while the FTSE 250 has greater exposure to UK consumers, builders, retailers and other domestically focused businesses.
As a result, continued underperformance in the FTSE 250 could indicate that rising borrowing costs are hitting the domestic economy more directly.
Banks face a more complicated outlook. Higher rates can initially widen net interest margins as lending rates rise faster than deposit costs. However, prolonged borrowing pressure can slow mortgage demand, weaken business investment and reduce consumer spending.
(adsbygoogle = window.adsbygoogle || []).push({});The bond-market move comes as higher oil prices revive inflation concerns. Bank of England Governor Andrew Bailey told lawmakers that energy prices had shifted inflation risks to the upside. UK mortgage rates have already risen by about 0.75% points since the Middle East conflict resumed.
The next warning signal would be continued gilt-yield increases alongside weaker UK stocks and sterling. Such a combination would show that the gilt sell-off is no longer confined to government debt and is placing broader pressure on UK financial markets.
