Treading the UK gilt market tightrope

28 October 2025

By Paul Brice (University of Oxford)

Introduction

Recent months have seen a considerable media narrative around the state of the UK bond (“gilt”) market – and potential implications for the UK’s public finances. In particular, over the past year there has been an escalation in the yields on longer-dated bonds – albeit that this has recently abated to some extent.  The UK has not been alone in seeing yield escalations in recent years: other developed economies have also seen rises. 

None of this is to suggest that the UK is on the verge of catastrophe: as recently as 22 August 2025, the credit rating agency Fitch affirmed the UK’s Long Term Issuer Default Rating at AA- with a Stable Outlook.  Whilst the current ratings from Fitch and other rating agencies are not the highest that each agency can ascribe, they still imply a very low level of default risk.

However, given the scale of the UK’s current indebtedness and associated interest burden, any material change to market yields – up or down – does matter in the context of the public finances given the implications for the cost of debt on new issuances: the UK’s current debt interest cost comfortably exceeds £100bn per annum – close to its annual expenditure on education; and considerably more than its expenditure on defence.  Net public sector debt at close to £2.8 trillion (allowing for inflationary uplifts in index-linked gilts but excluding unfunded pension liabilities) has risen to approaching 100% of GDP – with notable steps up in response to the Global Financial Crisis and the COVID pandemic. 

Against this backcloth, this blog reflects briefly on how gilt market responses might impact tax policy formulation – fully acknowledging recent bond market commentary by others, including the Institute of Fiscal Studies¹.

Implications for tax policy formulation

Tax policy is clearly just one element of overall fiscal policy – with other components including current spending, investment and levels of borrowing, all in turn influencing both the overall scale of indebtedness and the serviceability of debt.  

There is a seductive temptation to think that tax policy is simply about domestic political choices – that governments can tax, or not, as they see fit to fulfil their political ambitions and serve their democratic mandates. In a strict sense, this is true: in the UK, it is the case that if Parliament passes the necessary legislation around a tax policy decision, then the policy becomes enshrined in law. 

But in a leveraged economy participating in a globalised, inter-connected world with competition for mobile capital, investment and talent, the realpolitik can be different. Yes, Parliament is sovereign, but there are other forces at play in the determination of tax policy success – including the responses of the gilt market.  

Unlike Parliament, the gilt market is not democratically elected; it is essentially financially driven; and it is internationally atomised. It is the product of previous borrowing choices. Nonetheless, despite its lack of official political role, through its pricing responses to fiscal choices, the gilt market can be a “clear and present” influence in tax policy – an implicit arbiter of a tax policy’s economic impact. 

By way of example, the UK’s September 2022 “mini Budget” included a significant element of unfunded tax cuts. The “mini Budget” was followed by a vigorous adverse gilt market response given market perceptions around both fiscal discipline and the associated economic implications of the measures including additional borrowing. It must be emphasised that one element of the increase in the overall yields related to the impact on Liability-Driven Investment (“LDI”) strategies used by a number of pension schemes – but the market reaction was swift and adverse all the same.

Given current indebtedness levels, any tax policy decisions which have the effect of materially increasing the cost of interest on new issuances of gilts could be economically (and socially) counterproductive; whereas policy choices which reduce yields could be economically and socially beneficial.  This gives the gilt market an “amplifying effect” to the economic impact of tax policy choices. Consciousness of the market can provide a further guardrail in policy setting.

This blog makes no attempt to single out individual tax policy choices and generalise around their potential gilt market impact. Nor does it seek to speculate about the forthcoming Budget or the UK’s economic outlook.  The position is highly nuanced and multi-dimensional – tax policy being just one component of the “fiscal jigsaw” alongside public spending, investment and borrowing. 

Nonetheless, very simplistically, it would seem that clearly-costed, successful “pro-growth” tax policy choices - for example, providing business tax incentives which stimulate incremental private investment whilst not compromising fiscal guardrails or driving inflation – might ultimately lead to a broadening of the tax base (business and employment); and, absent further increases in borrowing, an improvement in debt serviceability.  If such a policy and its consequences were well-received by the gilt markets, then – all other things being equal – yields (and, in turn, the cost of debt on new issuances) might reduce. 

Conversely, a policy choice which threatened to weaken economic growth and debt serviceability through high “deadweight” costs or reductions in business confidence; stimulated inflation; which signalled a weakness in fiscal discipline; or reduced the UK’s attractiveness as an investment location, might have the reverse effect.

Ultimately, of course, the “market will speak”. Indeed, the evidence from recent examples – both in the UK and US - is that government bond markets are vigilant and responsive. The gilt market is a “hard reality” that UK tax policy advocates need to be aware of. 

Given the UK’s scale of leverage, it seems that, as part of considering its economic impact, an analysis of potential gilt market reaction and any impact on debt servicing costs – positive or negative – should logically be a consideration in any material UK tax policy formulation, advocacy and critique given the UK’s current scale of financial leverage and associated debt costs.

Reference 

¹. See, for example, “The Budget and bond markets: ‘when you’re in a hole, stop digging’”. Moyeen Islam, IFS Green Budget 2025, 16 October 2025.