A bond market crisis that rocked Britain's economy two years ago has cast a long shadow over the country's July 4 election which will likely linger as a new government finds its feet.
Spooked by plans by the ruling Conservative Party's then-Prime Minister Liz Truss to slash taxes in September 2022, the scars of the bond rout remain.
Politicians have avoided grand economic plans in the current election campaign for fear of waking the bond market dragon. The opposition Labour party has used the episode, which also pushed sterling to record lows and jacked up mortgage rates, to attack the Conservatives' economic record.
Labour, well ahead in the polls, looks set to inherit one of the highest debt loads in UK history. Yet looming interest rate cuts could work in its favour.
The following five charts outline the sort of bond market awaiting the next government:
1) STILL-HIGH BORROWING COSTS
After the 2022 mini-budget crisis, Britain's 10-year bond yields soared to a 14-year high on fears about high levels of borrowing and as complicated pension fund investment strategies were caught in the meltdown. Yields rise as prices fall.
The Bank of England stepped in to stabilise markets, yet 10-year gilt yields remain well above those in benchmark euro zone bond issuer Germany . That's largely because stickier UK inflation forced the BoE to hike rates to 5.25%, compared with 4% in the euro zone.
Yet there is some reason for optimism. Barclays analysts reckon the "idiosyncratic risks around gilts seem much less than in other markets", as the rise of the far right rocks France and unsettles Europe.
2) BRITAIN TESTS THE MARKET
Britain's borrowing needs, exacerbated by the COVID-19 crisis and the Ukraine war that sent energy prices soaring, remain high.
The 2024-25 financial year is set to be the second-highest for government debt issuance on record at 278 billion pounds ($350 billion). Pressure is unlikely to ease any time soon, even before new policies are considered.
Separately, the BoE is meanwhile cutting its bond holdings by 100 billion pounds a year, including through active sales - meaning more pressure on the market to soak up new debt and raising some concerns about financial stability.
3) RATE CUTS ARE COMING
The good news for Labour's Rachel Reeves, set to become Britain's first female finance minister, is that BoE rate cuts will likely start soon.
Inflation has slowed back to its 2% target amid tepid growth, and traders anticipate a first cut in August or September. Money market pricing suggests rates will fall by around 1.2 percentage points by the end of 2025.
"If you've got an economy that's slowing and interest rates are being cut ... you generally don't have a problem selling sovereign bonds," said Craig Inches, head of rates and cash at Royal London Asset Management.
4) SOLID DEMAND
Demand for Britain's bond sales has been strong, with record bids for one issue in March. Rate cut bets have made government bonds appealing - bond prices rise as rates fall, as older, higher-yielding debt becomes more attractive than new issuance.
Prospects for stability after a period of political and economic uncertainty has also boosted sentiment towards UK assets.
Yet Royal London's Inches said inflation may pick up in the coming years and rates could rise again.
"That type of environment, where you've got very high levels of supply in a rate-rising environment, with poor debt-to-GDP ratios, that becomes problematic," he said, adding that borrowing costs would have to rise.
5) UNCERTAIN INTEREST COSTS
Britain's interest payments on its debt has surged along with inflation and interest rates, hitting a post-war high of 111 billion pounds in 2022-23, or around 4.4% of gross domestic product.
One problem for the incoming government is that forecasts for the debt interest bill have bounced around along with market rate expectations. Although rates are expected to fall, how low they will go remains uncertain.
This means that interest spending "is likely to remain a major source of risk to the fiscal outlook," Britain's budget watchdog said in March.
($1 = 0.7914 pounds)
