Technology recorded an increase in UK loan costs to the highest in 5 months due to the Iran conflict

UK borrowing costs soar on the eve of the Iran crisis

UK borrowing costs have surpassed 5% for only the third time since the Iran war, creating difficulties for Andy Burnham just days before he officially takes office at 10 Downing Street. The UK's 10-year government bond yield - a benchmark for a country's long-term borrowing capacity - rose as much as seven basis points on Tuesday morning, after a fragile ceasefire between Iran and the US broke down.

Tension developments between Iran and the US

The two nations have continued to exchange attacks for three consecutive nights, leading to a significant escalation of tensions, causing oil prices to rebound to levels not seen since mid-June. The situation caused Brent oil prices to increase more than 9% in a single trading session on Monday - the largest daily increase since May 2020.

The US military has launched another attack on Iranian military facilities, which, according to the country's military commander, will "continue to impose heavy costs on Iranian forces and reduce their ability to attack commercial vessels". Donald Trump also reinstated a blockade of Iranian ships in the Strait of Hormuz, while the United Arab Emirates (UAE) reported two oil tankers were attacked by Iranian missiles.

Impact on government bonds and interest rates

Government bond prices have soared globally, with US 10-year Treasury yields also rising more than 5 basis points on Monday.

Borrowing costs in the UK have been hit hard by the Iran war, as the country relies on energy imports and inflation remains persistent. High inflation often causes traders to demand higher interest rates on bond holdings, as rising prices in the economy can reduce investors' real yields. They also predict that central bank interest rates will remain high for longer as prices remain elevated.

Challenge for Andy Burnham

Sharp increases in borrowing costs are posing a major financial challenge for Andy Burnham just days before the former Manchester mayor officially becomes Prime Minister. A 60-day ceasefire between the US and Iran in June has helped ease pressure on public finances in the past few weeks, with 10-year bond yields falling more than half a percentage point from their peak in May.

“The rise in energy prices has the market also rushing to adjust its forecasts for more interest rate hikes,” said Kathleen Brooks, director of research at XTB. "There is now a full rate hike from the Bank of England predicted before the end of the year."

Markets also expect the US Federal Reserve (Fed) to raise interest rates this year, with markets predicting a 40% chance that the Federal Reserve Open Market Committee will decide to raise interest rates when it meets this month.