The media claims UK government borrowing costs have soared to 5.6%, spelling financial crisis for Rachel Reeves. But that's nonsense. Bond yields are being distorted by a stock market bubble, not by government risk. Reeves shouldn't issue bonds at these rates — she should wait for the crash that's coming. In this video, I explain how bond yields really work, why the markets have it wrong, and what a wise chancellor should do now.
This is the audio version:
This is the transcript:
In August 2025, it is being said that UK government borrowing costs are rising to 5.6% per annum, and as a consequence, Rachel Reeves is going to face a financial crisis, and there are a lot of people who are rubbing their hands with glee. And for once, I'm going to say Rachel Reeves is on the right side of this story and the financial markets have got it wrong.
Let's be clear as to why that is the case.
First of all, UK government bonds are not carrying interest rates of 5.6% at present. The vast majority were issued at rates somewhat lower than that, and the rate of interest paid on a UK government bond is fixed throughout its life. And as a consequence, the 5.6% is what people are earning on government bonds in the second-hand bond market, but that is not the price that is being paid by the UK government.
And if the UK government was wise, and I admit there is a very big if in that last statement with that word doing a great deal of work, but if it was wise, then it wouldn't be issuing bonds right now, because why on earth would it choose to pay interest of 5.6% for maybe years to come if it were to issue bonds now when it could instead borrow from the Bank of England at present and wait for interest rates to come down, as I am quite sure is going to happen.
So let me do a little bit of explanation.
Right now, UK stock markets are at record highs. If you want to see the chart, there it is.
At the time that we are recording this video, the market is at around 9,280 and has been over 9,300, and these are levels it has never reached before.
The point is, investors are pouring money into the FTSE 100 at present, following in the footsteps of what is happening in the USA, where AI is creating a massive stock market hike, and they're selling government bonds to buy shares. And the simple fact is that when people sell government bonds, their price falls, and so the yield rises.
Let me explain that, because it seems that very few people understand the very simple mathematics involved in this process, but which is fundamental to understanding why this supposed interest rate crisis is arising.
Suppose that a few years ago, five years ago, maybe, the UK government issued a 30-year bond at £100. And they promised to pay £4 of interest a year on that bond. In other words, the fixed interest rate on the issue price was 4%. And that interest will be paid, whatever the market does, until the bond comes up for redemption, which would, on the basis of this example, be in 25 years' time, and that's it; as far as the government is concerned, nothing will ever change.
But now suppose that the people who own that bond decide they want to put all their money into the stock market because they think that there is money to be made there, and as a consequence, they're all trying to sell the bonds they own.
If everybody tries to sell the bonds they own, guess what happens? The price falls. And let's suppose that the price of that £100 bond now falls to £80 in the second-hand market.
What goes on then?
Well, as far as the government is concerned, nothing, because it still pays £4 a year in interest.
But for the person who buys that bond at a price of £80, the interest rate now looks like 5%. They paid £80 for the bond. They get £4 of interest, and so the yield has apparently gone up from 4% to 5%, even though, as far as the government is concerned, nothing has happened.
And now let's suppose, as I am expecting, that the stock market crashes.
It fell by nearly 50% between the beginning of 2000 and late 2002 when the dot.com crash happened, and I'm expecting there to be a fall of broadly similar proportions as a consequence of the AI bubble bursting. It would be quite possible in that case for the price of that government bond to increase to £120 as people pull their money out of the stock market and put it back into bonds.
Let's just look at what that does to the bond rate. The same £4 is paid, but now somebody buying a bond would've paid £120 for it, and therefore the yield would fall to 3.3%. The yield has fallen as the price has risen. But the point is that markets move and not government risk, and that's exactly what we are seeing at present.
The only reason why the UK government appears to be paying interest rates of 5.6% or more per annum at present is because there is this massive speculative bubble going on inside the FTSE 100 and inside global stock markets, which are pushing up the prices of shares, dragging money out of bond markets, and as a consequence, pushing up the apparent interest rate paid on government bonds, even though the actual sum, which departs the government bank account, will, in most cases, not change at all.
Bond yields are being altered as a consequence of the spike in speculation in share prices, but not because of anything to do with the change in the risk of lending to the government, whatever the media might like to say.
So this current 5.6% yield that we're seeing in bond markets is very likely to be temporary.
The moment that we see stock markets begin to fall - and everybody is beginning to expect that to happen from the New York Times to the Financial Times, to me - and quite a lot of other people as well - there is going to be a financial collapse.
The government should, as a consequence, quite simply not be issuing bonds at this moment. There is no reason to issue bonds at 5.6% when they could instead borrow from the Bank of England for the time being and wait until the rate has fallen before issuing bonds again, if that's what they wish to do.
And the government should also be telling the Bank of England to stop its quantitative tightening process at present because that is selling bonds right now at an undervalue and crystallising losses for the government, which are wholly unnecessary.
All this market noise should be ignored by a wise chancellor.
A wise chancellor would be sitting back at the moment.
A wise chancellor would be withholding bond issues at present.
A wise chancellor would realise everything that I have said is true.
Again, I have to say the words 'a wise chancellor' are doing a lot of work in the last few sentences that I have said, because maybe we haven't got a wise chancellor, and maybe they are therefore going to carry on issuing bonds.
But the reality is, if Rachel Reeves had any sense, she would be sitting out this peak in interest rates on the bond markets because they're going to fall.
It's time that she used all the financial instruments available to her.
It's time that she told the bond markets, "I'm not interested in the games that you play."
It's time she sent a message to the London Stock Exchange "You are fueling a bubble and I'm not going to play part of that game."
It's time she actually acted maturely and recognised that she is in control.
She doesn't need to borrow now.
She shouldn't be borrowing now.
She should be sitting out these interest rates.
And she should be issuing new bonds if that's what she wishes to do when the crash comes, because at that point, everyone is going to want them .
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People use the word ‘ignore’ in the wrong way. It’s become a word like affordable, minimum, and genocide where the government’s way of using it is now the mainstream way because of media amplification and I don’t like it.
What you appear to be saying is that Reeves should be cognisant of what’s happening in the bond markets, and acting on that she should stop issuing issue bonds at 5.6% or whatever it is, and finance the difference between tax receipts and spending by another method.
Ignore:
to refuse to take notice of
What did I get wrong?
Is Patrick a troll? One looks forward to the names of African leaders.
I suspect so – but sometimes trolls present comments that look reasonable at first. If he is he will go soon.
Early 1980s – interest rates around 14% (remember that?).
I was working outside of the UK @ the time. Some gov bonds (gilts) bought through the post office (yup you could do that) paid interest tax free to those classed as “not in the UK”. Interest was paid every 6 months. There was a modest price drop in the value of the gilt on the day after the pay-date for the interest. Almost as regular as clockwork interest rates gradually went lower & if one waited a month and one could sell the gilt & buy another – with no capital loss. Rinse and repeat. Over 12 months doing that I got a return on gilts of perhaps 130% – just from the interest payments. I even charted the whole thing out (the gradually failing interest rates vs daily changes in gilt prices – time consuming cos no computers & all graph paper). point: interest rates go down, gilt prices go up.
I agree that Reeves should just get the BoE to print & issue money to the gov.
hmm perhaps gov gilts are worth revisiting given interest rates will decline.
It was called ‘bed and breakfasting’ and is not possible now under rules introduced on the matching of purchases and sales.
Ah well, I made a bit of dosh whilst it was still possible. No more bed & breakfasts with gilts – boo hoo most unsporting.
Alternative observations
1. The UK market is not in a bubble. It is one of the few advanced market equity markets that is undervalued in absolute terms, against its own LT history, and against other markets.
2. People are buying UK equities because of 1, not because they are selling bonds. The bond market jitters are out at 30Y across the globe. 10Ys are trading in a well defined range and no evidence of sustained selling. At these real yields that would be silly.
3. The full funding rule requires any Chancellor to match projected financing requirements through issue of debt. The Chancellor cannot simply chose not to issue bonds.
Other than that….
Good luck when the crash comes – because it will.
If you can’t see that, you’re amngst the vast majority, but they were the people burned in 2000 and 2008, and earlier. I wasn’t.
Point 3 took my eye. Full funding rule? To avoid using you as google, I did a bit of hunting. I understood that the government is obliged to issue bonds to match the difference between spending and revenue?
I would imagine that it is a self imposed rule.
Is that so?
Yes.
Richard, thanks for explaining the second hand market in government bonds.
As usual this story is peddling the myth about the cost of the UK government “borrowing”.
Very useful, thank you. Gradually getting more acquainted with bonds and today’s piece was very clear.
Thanks
So, long term money is being pulled out of savings etc., to take advantage of a perceived boom that is just going to end in tears. And the media thinks that the trading price of the ponds is the new interest rate the government has to pay the bondholders, despite the agreement on those being set when they were issued.
This does not sound like a financial ‘system’ to me. It sounds like chaos or if you like, a load of old bollocks.
‘Wise chancellor’? I don’t think I have ever seen one in my lifetime Richard!
Much to agree with
I’ve been thinking that stock market prices would depends on flows of wealth and that the main contributor of these flows isn’t the speculation from the rich but is capital flowing from companies to employees to their retirement accounts through PAYE in the major economies.
I understand that most people who draw upon their pensions would be more likely to be invested in safer investments like government bonds…but wouldn’t the flow in outweigh the flow out and therefore I cannot understand how there can be such volatility in stock market prices…!
Shares are priced at the margin – where the trading is, and not where the long term holders of stock, like pension funds are.
BUT, pension fund managers love high prices – it makes them look very smart.
That said, small sales volume can have massive impacts on prices.
Do you anticipate in the longer term the longer term gilt market will remain at current levels? My understanding is that there would need to be a change in the attitude to risk of most Pension Providers asset managers and that would have to come from the clients themselves. Even a small amount of activity can change their prices but you are you saying the longer term trend is lower government borrowing costs?
I most definitely do think that is the direction of travel.
Ding!
The light just went on! For the first time ever, I know understand the inverse relationship between 2nd hand bond prices and effective 2nd hand bond interest rates paid. In fact, for the first time ever, I understand what a 2nd hand bond IS!
Oh joy!
KUTGW!
Phew
My mission is done…
But all the rest need to hear too, si I will carry on
Fab. Thank you so much, now for the first time understood what is meant by yields!!!
Yay!
First, I am not too bothered by this rate but if I were I would keep issuing gilts but for shorter maturities. The maturity profile of the gilt market is very long compared with other countries because, in the past, there was huge demand for 30 year bonds. In fact, for most of my career the government paid a lower rate on 30 year bonds than they did for 10 year bonds. This has now changed so the government should alter it’s issuance strategy.
Now, your suggestion of not issuing gilts is, in effect issuing 1 day gilts at the rate paid on CBRAs and I would not go that far but the DMO should alter the mix of gilts it sells.
Noted
But I am not suggesting issuing any binds
I am suggesting using the Ways and Means Account
Yes, but money spent by government is either drained by tax, (net) gilt sales or it accumulates in CBRAs where interest is paid at the base rate.
BoE, DMO and HMT are all government so it doesn’t matter who pays.
Of course, interest is a transfer of money to the (mainly) wealthy so should be properly taxed…. and don’t get me started on remuneration of Reserves! But that’s another story.
OK, I see your logic flow now, and my answer is, of course, end interest on all central bank reserve accounts .
Saw this on another blog site a couple of days ago:
The UK government has just sold £5bn worth in three-year bonds in a scheduled action. Demand was good, with the auction covered 3.16 times. The bonds were sold with a yield of 4.375%, due in 2028.
Source: Guardian Business 27/08/2025 (https://www.theguardian.com/politics/live/2025/aug/27/conservatives-consider-deal-afghanistan-migrants-uk-politics-latest-updates-news?CMP=share_btn_url&page=with%3Ablock-68af0d4d8f080ebbe15bcfc0#block-68af0d4d8f080ebbe15bcfc0)
Quite right, Mr Kirby, I had a quick look at the Gilt Issuance history for August, and the latest issue on 28th for 2028 redemption was at an interest rate of 4 3/8%. Worth noting, however, that all gilts are sold to Gilt Edged Market Makers, so any private punter buying them always buys second hand. That particular issue is priced today at £101.08 on A J Bell’s website. (Issue price, obviously, £100).
Very clear and concise. I only wish Rachel Reeves subscribed to your blog. I do wonder, though, whether the coming AI induced crash will be worse than the dot.com bubble. The period between 2000 – 2002 seemed more like previous crashes e.g. the South Sea bubble or the Dutch tulip bulb crash. Pure speculation that ran riot until running out of road. However the hysteria surrounding AI seems to me to have an added dimension – the “product” may actually be fundamentally flawed and actually harming the public. We are already seeing cases like the tragic suicide of Adam Raine and the Guardian Online is reporting that a ChatGPT model gave researchers detailed instructions on how to bomb a sports venue and how to weaponise anthrax. If correct, then may be AI will also collapse in a mire of product liability law suits. If so, I bet the developers of these AI models won’t leave it to AI to mount its legal defence. It is possible that the concept of limited liability may not provide investors with complete immunity if any statutes are involved that include the ‘consent, connivance or neglect’ formulation for personal criminal liability. All it would take is for someone to cause mass damage or worse with a terrorist bomb built under the guidance of AI for the these investments to begin to look very unwise. The investor could, arguably, be held to be a ‘shadow’ director.
That is an interesting idea.
But, how often has shadow directorship ever been successfully used to prove liability? I used to talk about it to clients, but always thinking it was a hollow idea without teeth.
I agree that in reality prosecutions of shadow directors are, until now, extremely rare but the threat still exists and often the culprit is not pursued because the main directors of the company are far easier to nail. I do have direct experience of a senior solicitor who was so closely tied through his professional relationship with his client company which had been involved in some extremely dodgy property transactions being accused of acting as a shadow director. The upshot was that the directors were charged with fraud and the solicitor, as a get out of gaol free card, was spared prosecution as a shadow director provided he immediately surrendered his practice certificate, resigned from the Roll and undertook to never seek restoration. It ended his legal career. This was many years ago now. However, the stakes are much higher now and it is not difficult to see a time when the politicians legislate to lift the corporate veil – arguably section 157(2) of the Environmental Protection Act 1990 provides such a pathway. The definition of “any director, manager, secretary or other similar officer” is sufficiently wide to embrace some active investors. And all this assumes that any legal action would be pursued in the cautious confines of the UK judicial system rather than across the pond.
To end on a lighter note, as one US lawyer put it to me: why are there more toxic waste dumps in New Jersey than there are lawyers in New York? Because New Jersey got the first choice!
Have a good weekend and try to get in some birdwatching.
Thank you. Some of that made me smile. And I like your optimism. As for the weekend, the weather forecast looks good, I think some birdwatching might happen.
I see the IPPR think tank agrees with you on this and is urging her to do just that.
https://www.theguardian.com/politics/2025/aug/29/treasury-tax-big-banks-quantitative-easing-windfalls-thinktank
Miracles happen occassionally. But this one is bleeding obvious.
You mentioned in a previous blog post the accelerating volume of money going into US shares is leading to an inevitable crash. My first thought was; where has that vast volume of money come from? You mentioned in this post, (answering my question) that it’s the selling of bonds that’s funding this spree. This raised other thoughts (apologies in advance if they make no sense) Is the same process happening in the States with the selling of Treasuries? And are Treasuries bought by other countries also being offloaded? Is the change in bond price the only indicator that the selling of bonds in the UK are funding the buying of stocks? If other countries are offloading US Treasuries, could this be a similar movement that Carney made when Canada was threatened by tariffs back in April but now being used in other countries to threaten Trump and his tariff addiction.
Remember, all trades are at the margins. If 5% of the market moves the impact is massive in price terms because most people hold savings products for the long term.
The real question is do herds move together? The answer is yes. So a crash in the US will result in a worldwide crash.
Remember there is nothing rational about this: people believe the market is going to rise right now. Soemtime soon they will believe it will crash. Then the stampede begins.
“there is this massive speculative bubble going on inside the FTSE 100”
That is questionable. You cite AI stocks as the reason for stock market euphoria, that might be true in the US but examine the make of the FTSE100 and there are no AI tech companies. The index is more a construction of solid dividend payers.
Good luck if you think a US stock market crash will not pull the Uk down with it.
These is an interesting point to be made about rising bond yields, Richard, in that this affects to returns from guaranteed pension-funded annuities. These have increased appreciably over the summer. I ran some open market option quotes this morning to illustrate this. The figures below assume a below market average adviser charge of 1% of the fund.
A 68-year old in excellent health purchasing an annuity with a £100,000 pension fund will now be able to secure a “Real Annuity” (i.e. one pegged to any adjustments in the RPI) of £6,100 – up from £5,728 since late May. An annuity increasing at 3% p.a. now offers £6,510 (was £6,230), one increasing by 5% p.a. now offers £5,374 (was £5,113), one increasing at 8.5% p.a. now offers £3,681 (was £3,352).
Finally, a fixed “Nominal Annuity” has risen from £8,337 to £8,397.
Not advice, but interesting nonetheless.
Agreed.
And making me think…
I must add that, unfortunately, we are not a healthy nation. I spoke with L&G a short while ago, and their view is that around 60% of people buying pension-funded annuities will benefit from an uplift over and above standard rates due to health and lifestyle issues. That’s up from c.15% 25 years ago. Sure, the underwriting is more sophisticated today, but even so!
So, anyone considering buying an annuity with a pension fund simply must complete a copy of “The Retirement Health Form” to establish their “personal annuity rate”.
Sadly, the majority of people – and lazy advisers – just don’t bother, perhaps leading to the loss of many thousands of pounds over their remaining lifetime permanently. Which is really rather sad.
Noted, and good advice.
Editorial headline in today’s Telegraph: “Only the bond markets can save Britain now”.
Sometimes I think there is no hope for this country.
Reading some of the comments under your youtube video, there was the point made that when the bond maturers you get the principle back.
So in your example where someone buys the £100 4% bond for £80, if they then hold it to maturity, they will have gained an extra £20 as well as their effective interest rate being at 5%.
Now the commentator seemed to think this was the Government losing out, but of course it is the bond re-seller who sold their £100 bond on for £80.
I suppose the commentators’ thinking is that if bonds are offered at below coupon value pushing up their effective interest rate, that the Government then has to offer new bonds at the increased interest rate to compete. OTOH who can afford to keep buying at £100 and selling at £80?
I chose a long bond to diminish the impact of this.
It occurs to me that there may be the wrong interpretation being put on the bond reselling market. I believe many view it as a comment on how the markets believe in the Government – so if bonds are sold below coupon value and thus push their effective interest rate up, it is saying the sellers have less faith in the Government.
Actually though, doesn’t it really say more about the desperation of the sellers. For your example, if a seller is prepared to lose money through inflation (since they held the bond for 5 years so had £20 of interest, but £80 in 5 years time is not as valuable as £80 today), then surely that means they need cash more than thinking the Government is not going to pay 4% for another 25 years plus the original £100 back at the end.
Or, they think there is a better opportunity elsewhere, justifying the loss…
Would you suggest the BofE re start QE and buying in medium and long dated gilts to flatten the yield curve and bring longer term interest rates down? What is the risk or downside of such a policy ?
I wuld not suggest that at present: I am simply saying stop quantitative tightening and stop selling bonds, and stop paying interest on central bank reserve accounts. All are legal and possible.
What mechanism could be used to borrow from the BoE rather than selling bonds? The full funding rule which is DMO policy requires taxes and borrowing to equal proposed spending. Why would the BoE agree to this when they are not supposed to interfere with fiscal policy and are only responsible for monetary policy. Spending by the government without locking money up in bonds sold could lead to inflation as investors have to spend on other assets rather than bonds. If something is likely to lead to inflation I can’t see the BoE agreeing to it?
Governments can change rules. That is their role. The Bank of England has to comply with what they are told to do. Likewise the DMO. And I am suggesting a short term change of a type commonplace before 2006, when markets functioned perfectly well. You are making a case for things that simply aren’t true.
Richard, I’m wondering what you made of the IPPR’s appearance on Friday’s Today programme? They seem to be saying much the same as you about QE, BoE bond sales and interest payments on commercial bank deposits. But you’ve been saying it for a lot longer.
I did not hear it, sorry.
I welcome late arrivals to the party.
I had to work with the author of their report once. I will say no more.
If the crash comes and I think it will, is the Government going to bail out the bad investments by lowering interest rated and doing more QE. That was the wrong solution, they should let the asset and house prices fall and allow the market to sort out the problem. If anyone has shares, a unit trust or investment trust or pension the should not be ably to use the ‘Miss Sold’ excuse ‘I want my money back’. They shouldn’t have taken the risk!
Over the last 40 years we have had a capitalist business environment but Socialism is used to bail out the capitalists.