The interest rate on UK government debt remains stubbornly high—and it’s eating into the public purse. Around 8% of total government spending now goes purely to pay interest on past borrowing. That’s money not spent on the NHS, schools, or infrastructure.
The current Labour government inherited a toxic mix: huge debts and higher-than-normal interest rates, courtesy of Liz Truss’s disastrous 2022 mini-budget. Her unfunded tax cuts spooked the markets, sent gilt yields soaring, and shattered the UK’s fiscal credibility.
Rachel Reeves’ economic strategy—cautious on both spending and taxation—is designed to keep investors onside. If Reeves can bring gilt yields back to the low levels seen under Gordon Brown, over £100 billion a year could be freed for public spending. But if the markets lose faith, the government will face brutal choices: more austerity or tax hikes.
Yet there are bigger forces at play. The UK’s borrowing costs aren’t just shaped by Truss’s mess or Reeves’ caution. Three global trends are pushing up rates everywhere.
1. Donald Trump’s Debt Explosion
Across the Atlantic, the US is borrowing at a staggering rate to fund Trump’s tax cuts, ballooning deficits, and the militarisation of ICE (which increasingly operates like a private army). Add to this Trump’s erratic trade policy—tariff threats one day, U-turns the next—and an American economy flirting with recession.
When the world’s largest borrower is paying more to service its debt, every other country’s borrowing costs rise too, including the UK’s.
2. De-Dollarisation and the End of Easy Money
Since Bretton Woods in 1944, the US dollar has been the world’s reserve currency. Over half of global foreign exchange reserves are held in dollars, and around 80% of all forex trades involve the greenback. This demand allows Washington to borrow cheaply, effectively making the rest of the world fund US deficits.
But de-dollarisation is accelerating. The BRICS bloc (Brazil, Russia, India, China, South Africa—now joined by Saudi Arabia, Iran, Egypt, Argentina, the UAE, and Ethiopia) is increasingly trading in national currencies. India and Russia now trade oil in rupees and roubles. China and Brazil have bilateral settlement in yuan and reals.
Russia’s expulsion from SWIFT after the Ukraine invasion turbocharged these shifts. Even West African nations, through ECOWAS, are planning a shared “Eco” currency to loosen dependence on the dollar and euro.
As demand for dollars falls, US borrowing costs rise—and because global capital is finite, every major economy, including the UK, competes for the same pool of money.
3. The Yen Carry Trade Unwinds
For decades, Japan’s near-zero interest rates made the yen the go-to funding currency for global investors. Hedge funds and banks borrowed cheap yen to buy higher-yielding assets, including UK government bonds.
Now, with Japan battling inflation and raising interest rates for the first time in years, this carry trade is unwinding. As that cheap capital dries up, countries like the UK are forced to pay more to attract investment.
The Stakes for Rachel Reeves
Rachel Reeves may look cautious, but the stakes are brutal. Markets trust her—for now. The FTSE is at record highs. But a political stumble—climbdowns on welfare reform, poorly handled tax changes—and that trust could evaporate overnight, sending borrowing costs higher.
UK interest rates aren’t just about domestic politics. They’re tied to Trump’s deficits, the decline of the dollar, and Japan’s demographic time bomb. Reeves can’t control these forces—but she has to manage their consequences.
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