UK government borrowing costs are poised to reach a 34-year high compared to Germany, amid growing uncertainty about how quickly the Bank of England can lower interest rates.
The gap between UK and German 10-year bond yields, known as the spread, has expanded to as much as 228 basis points following recent official data that revealed a significant rise in wage growth.
If this trend continues, it would represent the largest difference between British and German government borrowing costs since the early days of German reunification in 1990, surpassing the levels seen during the bond market crisis triggered by Liz Truss’s mini-Budget two years ago.
The increase in UK bond yields—the returns promised to investors who purchase government debt—comes after traders reduced their expectations for the Bank of England to cut borrowing costs next year.
Financial markets now suggest that the Bank of England may not lower interest rates again until as late as May, following a 5.2% wage increase in the three months leading up to October. This rise exceeded analysts’ forecasts of a 5% increase and was up from 4.9% in the previous quarter.
Total compensation, including bonuses, surged from 4.4% to 5.2%, well above the expected 4.6%.
As a result, traders now estimate there is only a 40% chance that the Bank of England will implement three interest rate cuts next year, down from 80% before the new figures were released.
Rob Wood, Chief UK Economist at Pantheon Macroeconomics, commented, “Facing this renewed trade-off between weaker growth and persistent inflation pressures, the Monetary Policy Committee is likely to hold interest rates steady this week and proceed with caution. We anticipate three 25 basis point rate cuts next year.”
Andrew Wishart of Berenberg added that the UK is dealing with “a challenging mix of declining employment and rising wages,” which will present “difficult considerations for the Bank of England.”
