Long-term borrowing costs in the United Kingdom reached their highest level since 1998 on Wednesday, driven by mounting concerns over inflation and the economic fallout from the ongoing conflict in Iran. Yields on 30-year government bonds, or gilts, surpassed 6 percent for the first time in 28 years before retreating slightly later in the day. This benchmark level of borrowing costs has not been observed in any G7 economy since Italy’s debt crisis during the eurozone turmoil in 2012.

The surge in yields intensifies financial challenges for Prime Minister Andy Burnham and Chancellor John Healey as they prepare for the upcoming Budget later this month. With the national debt nearing £3 trillion, higher interest payments limit the government’s fiscal flexibility to advance key initiatives, including expanded council house building, social care reforms, and increased public control of utilities.

Globally, government borrowing costs have been climbing amid fears that the war in Iran will hamper economic growth and drive inflation higher. The 10-year US Treasury yield—a key reference for global borrowing costs—rose to 5.33 percent, a level last seen in 2002. The situation in the Middle East further deteriorated following an attempted hijacking of a flight bound for Tel Aviv, which heightened security and terrorism concerns.

Economist Mohit Kumar of Jefferies noted the stalemate in US-Iran negotiations coupled with heightened risks evident from recent events, underscoring the fragile geopolitical climate. Against this backdrop, financial markets have increased expectations that the Bank of England will raise interest rates to manage inflationary pressures. Traders currently forecast an increase in the base rate from 3.75 percent to 4.75 percent over the next 12 months.

Catherine Mann, a member of the Bank of England’s Monetary Policy Committee (MPC), emphasized the need for rate hikes to “maintain credibility” in the fight against inflation, particularly amid uncertainty about inflation dynamics and potential second-round effects. Inflation in the UK has risen to 3.1 percent and is projected to exceed 4 percent by early next year, fueled by record diesel prices—around £2 per litre—and expected increases in household energy bills of approximately 16 percent starting in January. Mann voted in favor of raising the base rate to 4 percent at the last two MPC meetings but was outvoted by the majority.

The strain on financial markets was echoed in the equity sector, with the FTSE 100 falling as much as 2 percent in its sharpest decline since May. Banking stocks were among the hardest hit due to the bond sell-off. Higher borrowing costs are beginning to impact the broader economy; house prices unexpectedly declined by 0.2 percent in September, reversing a modest gain from August, according to the Nationwide house price index. Economists point to subdued market activity and consumption against the backdrop of economic uncertainty and geopolitical tensions that are exerting upward pressure on energy costs and inflation.

Nationwide’s chief economist, Robert Gardner, highlighted that these factors have sustained market expectations for further interest rate hikes, maintaining upward pressure on mortgage rates and borrowing costs more generally. Money markets currently assign an 84 percent probability to a rate increase in November, indicating broad anticipation of tighter monetary policy in response to inflationary challenges.