UK set to pay highest 10-year borrowing cost since 1999 at Tuesday's auction, with yields possibly reaching 5.41%

The UK government is set to pay its highest yield since 1999 in an upcoming 10-year bond auction, as investors demand extra compensation for persistent inflation and potential spending increases in next month's budget.

The Debt Management Office (DMO) plans to sell up to £4.25 billion ($5.6 billion) of bonds maturing in July 2036 with a 4.875% coupon on Tuesday. Last month's sale of the same security recorded an average yield of 5.16%, already the highest level in nearly two decades.

Since then, 10-year gilt yields have climbed further, touching a 19-year high of 5.38% on Monday. On Tuesday, the yield stood at 5.41%.

The surge in UK gilt yields is part of a global rise in borrowing costs, as elevated energy prices intensify concerns that inflation will remain high for longer, forcing central banks to tighten policy further. Additionally, markets are worried about the massive scale of public borrowing and the resulting increase in debt servicing burdens.

Richard Carter, head of fixed income research at Quilter Cheviot Limited, said, "The borrowing data remains extremely challenging, and there are no signs of the Middle East situation calming down, so energy costs will stay high." He added, "Unless the growth outlook suddenly changes, the desire for fiscal discipline may go unfulfilled."

The UK may pay its highest 10-year borrowing rate since 1999

In the UK, traders expect the Bank of England to raise rates in November and have priced in as many as five rate hikes by the end of 2027. Meanwhile, the October 28 budget will be a high-stakes moment for Chancellor John Healey, who has been trying to reassure investors that Prime Minister Andy Burnham's government will maintain strict control over the spending purse.

On Monday, he spared no effort in his first budget to commit to fiscal restraint. Nevertheless, higher yields are still attracting some investors to buy. Last month's 10-year auction was oversubscribed by more than 3.6 times, the strongest demand since April 2020.

UK gilts may also receive support from the Bank of England's decision to pause its quantitative tightening (QT) program and stop selling long-term bonds to the market. Bids for this bond auction will close at 10 a.m. London time, with results to be announced shortly afterward.