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The government is facing higher costs for borrowing money with experts warning Rachel Reeves’ room for spending could be cut by as much as £6bn this year if bond yields remain elevated.

Yields on ten-year government bonds, or gilts, move in response to political pressures, instability or unexpected economic conditions across the mid-to-longer term.

With Labour’s leadership concerns and the inflation-inducing war on Iran by president Trump dominating global affairs, the bond yield has increased significantly over the past few months, rising to above 5 per cent and sitting near levels not seen since the 2008 financial crisis.

On Tuesday, the ten-year yield reached 5.1 per cent, before falling back very slightly by Wednesday morning, sitting at around 5.06 per cent, partly in response to prime minister Sir Keir Starmer remaining in place despite suggestion he could resign or be forced out.

Even so, that’s in contrast to being roughly around the 4.5 per cent mark for most of the early months of the year, briefly touching as low as 4.27 per cent in the days before the start of the conflict in the Middle East. Since then, most nations’ government bonds have risen notably, but the UK has been hardest hit, says Oxford Economics’ chief UK economist Andrew Goodwin.

“The increase in UK government bond yields since the start of the Iran war has been greater than in most other advanced economies,” he said. “Markets clearly perceive the UK has a bigger inflation problem and that tighter monetary policy will be needed to limit second-round effects from the energy shock, while political uncertainty has added to pressures at the long end.”

Research from Oxford Economics shows 10-year UK government bonds have increased by more than 70 basis points since the start of the Iran war – more than any other nation in their data, with the likes of Japan, Germany, the US and France rising around 40-45bps each.

In the UK, those ten-year yields are likely to stay at and above 5 per cent this year, believes Mr Goodwin, due to the mix of inflationary pressures – which could force the Bank of England to hike interest rates – ongoing fiscal uncertainty if Sir Keir is replaced later in the year and even changes in the pension sector, which have been big buyers of gilts previously. The absence of such could see the price fall, which in turns raises the yield.

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As government bond yields are effectively the price of borrowing money for those running the country, a higher yield means more money spent on repayments rather than elsewhere, such as public services or industry support.

And Oxford’s report calculates rising yields now, combined with expectations of a Bank of England interest rate rise and other market conditions, could see Rachel Reeves’ headroom reduced by £6bn to £17.6bn between now and the Budget later this year.

However, it also suggests that this shouldn’t specifically alter or impact fiscal policy due to Ms Reeves’ earlier choices.

“In recent years, rising gilt yields have had a direct impact on fiscal policy because successive governments have had little headroom. That’s not likely to be the case now, partly because the chancellor took the sensible decision to significantly increase her margin for error at the 2025 Budget,” the research report reads.

Matt Britzman, senior equity analyst at Hargreaves Lansdown, says the worry in financial markets is over potential knock-on effects of political instability domestically. “UK government bonds had a bruising session yesterday, with no real let-up this morning, as borrowing costs pushed back to levels not seen since the financial crisis,” he said.

“The 10-year yield is just shy of 5.1 per cent, while the 30-year yield is still above 5.7 per cent in early trading, as a cocktail of political uncertainty, rising oil prices, and renewed inflation concerns has landed at once.

“The worry is that pressure on prime minister Keir Starmer could eventually lead to looser fiscal policy, while higher energy costs are feeding expectations that the Bank of England may have to raise interest rates this year. It’s a tough mix: higher borrowing costs, weaker confidence and less room for the government to offer support if the economy slows.”