While markets remain focused on whether the Iran conflict will ultimately push the United States into fiscal distress, it is worth first considering the extent to which instability in the Middle East could impact Europe and Asia. In this regard, the United Kingdom already appears to be in a precarious position, with France not faring much better.
Following the full-scale military actions by the US and Israel against Iran, Brent crude oil prices have surged, breaking above the US$110 (HK$861.88) level. This development is likely to drive a significant rebound in global inflation, forcing major central banks to pause their rate-cutting cycles – or even resume tightening. In the UK, not only did the Bank of England keep interest rates unchanged at its most recent meeting, but markets are now increasingly pricing in the possibility of a 25-basis-point rate hike at the next policy meeting.
In the aftermath of the Bank of England’s decision, UK government bond yields have risen sharply across the curve. The 10-year gilt yield briefly surpassed 5 percent, reaching its highest level since the 2008 global financial crisis. As a result, the UK now faces the highest borrowing costs among the G7 economies.
However, the sharp rise in UK bond yields cannot be attributed solely to geopolitical tensions in the Middle East. According to data from the Office for National Statistics, the UK government recorded borrowing of 14.3 billion pounds (HK$149.4 billion) in February – significantly exceeding both analysts’ expectations of 8.5 billion pounds and the Office for Budget Responsibility’s forecast of 7.4 billion pounds. Excluding the pandemic period, this marks the second-highest February borrowing figure on record. The surge in borrowing was primarily driven by a sharp increase in debt servicing costs, which rose to 13 billion pounds in February – up 2.1 billion pounds month on month and 7.5 billion pounds year on year.
That said, the spike in oil prices triggered by Middle East tensions has become an additional force pushing UK yields higher. This implies that the government’s debt servicing burden is likely to continue rising, which in turn may necessitate further borrowing – creating a potentially self-reinforcing cycle. Should instability in the Middle East persist, the UK’s debt dynamics could deteriorate further.
While it may be too soon to conclude that the UK will repeat the sovereign debt crisis experienced in Europe in 2010, the current trajectory is nonetheless concerning. With public debt now approaching 100 percent of GDP, the UK is operating at a clearly elevated risk level. Investors should therefore not underestimate the country’s fiscal challenges, nor the mounting pressure facing the British pound.
Andrew Wong is a veteran independent commentator
