Pound, Gilts Weaken as Truss Energy Package Fuels Debt Fears

By Geoffrey Smith — The hit a new low and U.K. government bond prices slumped as markets took fright at the rising cost of getting the country through an energy crisis in the coming winter.

The pound tested $1.13 against the dollar, a level it hasn’t seen since 1985, before recovering a little later in the session, while the yield on the benchmark 10-year Gilt rose by 6 basis points to hit a new 11-year high of 3.35% after the government unveiled its latest measures to cap energy bills for businesses, which analysts estimated could cost between 25 billion and 40 billion pounds ($28 billion-$45 billion). Truss had already been forced into announcing a similar relief package for households, which is expected to cost over 100 billion pounds.

Businesses have warned that without government support, a wave of closures due to soaring energy bills will be inevitable this winter. Shevaun Haviland, director general of the British Chambers of Commerce, said that the plan represents “a clear step in the right direction” but warned that its time-limited nature – the support program will only last for six months – still leaves business in a position where planning for the long term will be nearly impossible.

“We understand there are a range of unknowns for the Government in looking ahead, but without further reassurance very few firms will make plans to invest or grow,” Haviland said in a statement.

The package to ease businesses’ pain came on the same day that fresh data showed an unexpectedly sharp rise in government borrowing in August, due largely to a big increase in servicing the government’s inflation-linked debt.

Central government debt interest payable was 8.2 billion pounds last month, 1.5 billion more than a year ago, and the highest August figure since monthly records began in April 1997, the Office for National Statistics said, pointing to the sharp rise in interest payments on inflation-linked Gilts.

Like most other developed economies, the U.K. borrowed heavily to get through the COVID-19 crisis, when tax receipts collapsed and spending to support the economy exploded. The budget deficit has been coming down in the last year as those support measures have been wound up and as the economy has reopened, but the 2.5 trillion public debt burden, at 96.6% of gross domestic product, was still up nearly 2 percentage points from a year ago.

The cost of servicing that debt is likely to consume more and more government revenue if continues to march higher, as the Bank of England’s forecasts (and most private-sector ones) suggest it will. That’s because a quarter of the U.K.’s public debt is funded by bonds that pay interest linked to the rate of inflation.

The government’s borrowing costs are set to come under further pressure if, as expected, the Bank of England raises again at its Monetary Policy Committee meeting on Thursday. Analysts expect the Bank to hike its refinancing rate by 50 basis points. The Bank has also signaled it wants to start selling down its portfolio of Gilts accumulated during years of running a ‘quantitative easing’, targeting net sales of 10 billion pounds a quarter. With the Bank joining the list of net sellers of Gilts, that’s likely to put even more upward pressure on yields.

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