Markets are a little calmer this week, though ready to react to any more tariff nonsense from the White House. The experience of the past few weeks suggests it might not be a very long wait. Once Donald Trump is accused of a climbdown, which was what he performed last week, there are risks he will react.
Watching these events unfold, there has been a certain amount of schadenfreude in seeing the limits of Trump’s power, and a president brought to heel by the bond market. Before we enjoy it too much, though, we should note that bond-market uncertainty, a rise in the cost of government borrowing, is usually exported from America to these shores.
That process began in January, when financial markets began to realise that tariffs were not just a campaigning device from Trump. It went into overdrive on April 2, “Liberation Day”, when the White House Rose Garden saw a puzzling set of tariff announcements.
Now, as I say, there is an uneasy truce. As I write this, ten-year gilt yields, at about 4.6 per cent, are a little lower than last week’s highs, but nearly half a percentage point higher than in December, before markets started to really worry about tariffs.
If we look across the world, the highest government bond yields are in a group of “Anglo-Saxon” economies: America, the UK, Australia and New Zealand. This country and New Zealand vie for which of the two has the highest yields. Canada, interestingly, is not part of the group, with much lower ten-year bond yields, around 3.1 per cent.
Nor are most European countries. Those who remember the eurozone crisis just over a decade ago, when Greece nearly came a cropper, with Spain and Portugal not far behind, may be intrigued to know that the governments of all three countries can borrow much more cheaply than Britain and the other Anglo-Saxons. Greece, Spain and Portugal have ten-year government bond yields, rounded, of 3.1 to 3.4 per cent, with Italy a little higher at just under 3.7 per cent. France is at 3.25 per cent, Germany roughly 2.5 per cent.
Even they cannot compete with Switzerland, where ten-year bond yields are just below 0.4 per cent. Rachel Reeves would give her eye teeth for Swiss borrowing costs, which would transform the outlook for the public finances and a debt interest bill projected to average £119 billion annually over the next five years.
As it is, her spring statement was dominated by rising borrowing costs and the need to respond to meet her fiscal rules. The Office for Budget Responsibility (OBR), using market data, increased its assumption of the average ten-year gilt yield over the 2025-29 period from 4.4 to 4.8 per cent, with that yield rising from 4.3 per cent at the end of 2024 to 5.2 per cent in 2029.
Why does the cost of government borrowing vary so much between countries and why is the UK, with a few others, so uncomfortably placed? A few years ago the Bank of England, on its Bank Underground blog written by staff members, talked of the special relationship between US and UK bond yields, quoting a newspaper report which said that the ten-year gilt “might as well be draped in the stars and stripes”.
These two big government bond markets on opposite sides of the Atlantic have similar characteristics. Both countries issue a lot of debt and both depend to a significant extent on foreign buyers to take on that debt, America more than Britain.
The first and most obvious reason why that special relationship exists is that the US and the UK operate with similar levels of official interest rates. Bank rate in the UK is 4.5 per cent, while the target range for the Federal Funds rate in America is 4.25 to 4.5 per cent; hard to put a cigarette paper between the two.
European official interest rates are much lower. The main rate of the European Central Bank (ECB), its deposit rate, is 2.5 per cent and is expected to be cut again this week, probably to 2.25 per cent, though some analysts are talking of a bigger cut. Eurozone countries have benefited from being part of the same grouping as low-inflation Germany.
Put simply, a lower level of official interest rates is needed to deliver similar or better inflation outcomes in the rest of Europe than in Britain or America. The Bank of England is contemplating a cut in rates next month and will probably do so, notwithstanding continued strong regular pay growth of 5.9 per cent. Any cut will, however, leave UK rates almost double those in the eurozone. It is a difference that persists under different circumstances. Even though Bank rate was very low in the 2010s, never rising above 0.75 per cent, the ECB deposit rate was frequently negative, below zero.
Low official rates make the argument even more so when it comes to Switzerland, where the Swiss National Bank’s policy rate is just 0.25 per cent.
What about debt? Are markets not reacting to the UK’s profligacy, and similar fears about America? Some say this, particularly about America. On a comparable basis, though, using OECD (Organisation for Economic Co-operation and Development) figures, general government debt last year was 93 per cent of gross domestic product in the UK, 117 per cent in both France and Canada, 137 per cent in America, 148 per cent in Italy and 180 per cent in Greece.
The eurozone benefits from low German debt, 64 per cent of GDP, which may now rise with its new government’s proposed relaxation of the debt brake. Switzerland has low interest rates and very low government debt, just 39 per cent of GDP.
Whether we could ever hope to replicate anything like that, given the pressure for higher public spending, is highly doubtful. We may just have to accept that, when it comes to the cost of borrowing, we will continue to be in a special relationship with America.
