Borrowed time

• Brent crude oil, which added a further +8.8% in dollar terms
• The euro, which advanced strongly against sterling at the end of the week as UK government borrowing costs jumped 

• Global equities, with major indices falling across the board. European and UK markets led the downward trend, falling -3.6% and -3.3% respectively in sterling terms
• Gold, which declined a further -10.5% in nominal terms

The UK’s borrowing costs have climbed to their highest level since 2008 as the Iran war left the Bank of England (BoE) with little choice but to keep interest rates on hold last week. Central bankers in the US, Europe and Japan also kept their key policy rates on ice, given how tricky it has become to forecast inflation. In the UK, the benchmark 10-year gilt yield (cost of borrowing) is now around 5%, up from 4.23% before the conflict. The 2-year gilt yield is around 4.6%, up from 3.5%. Yields on 10-year US treasuries and German bunds have also risen, but not quite so markedly. Rising bond yields have triggered a renewed sell-off in equity markets, as investors fret about where the off-ramp is for the Iran war and what the consequences of the continuing conflict might be. The gold price has also fallen to $4,200 per troy ounce. However, both gold and the UK’s FTSE 100 are currently around the same price levels as in mid-December last year.

A sustained rise in energy prices could push up inflation and drag on economic activity, hence the reaction of global equity markets. But the impact across economies will be unequal and interest rate policies may diverge as a result.

As a net importer of energy, the UK economy is highly sensitive to supply shocks. Typically, the BoE prefers to look through a transitory surge in inflation and focus on the underlying health of the economy. However, Russia’s invasion of Ukraine in 2022 exposed the UK’s vulnerability to gas market shocks. Although inflation was already high and rising after the Covid-19 pandemic, the conflict sparked a more persistent inflation problem which the BoE struggled to control. Rate setters at the BoE’s Monetary Policy Committee (MPC) are likely to be particularly focused on avoiding any such policy misstep this time around. 

Just six weeks ago, markets were pricing in one or two 0.25% interest rate cuts this year. At the time of writing, futures markets are now indicating a rate hike in June and July, with another in 2027. The BoE left rates at 3.75% last week, despite evidence of some underlying weakness in the jobs market: with wage growth (excluding bonuses) slowing to 3.8% from 4.1%, and the unemployment rate holding at its recent peak of 5.2%.

Given its greater energy self-sufficiency, the US is far less sensitive to exogenous shocks. But policymakers there are grappling with two other dynamics. First, awful recent jobs data, which showed that the economy shed 92,000 jobs in February rather than gaining 60,000 as expected. Second, the stimulus from President Trump’s One Big Beautiful Bill – which is helping consumers and businesses to absorb price rises – will begin to fade in April. US retail gasoline prices are their highest since October 2023 at around $3.72 a gallon – some 27% higher than before the Iran war and c.35% above 2026 lows. At the time of writing, futures markets are forecasting up to two 0.25% interest rates kikes, one this year and one next. The US Federal Reserve held rates at 3.5%-3.75% last week.

Bucking the trend, the Reserve Bank of Australia went ahead with a hike to its official cash rate last week, rising to 4.10% from 3.85%. The bank warned that a recession is possible if inflation is not contained.

The path for all interest rates is very volatile. Expectations for rate hikes may quickly unwind if the conflict in the Middle East de-escalates soon. For 2026, it is likely that economic growth forecasts will nonetheless be revised lower.

• UK youth unemployment – As noted, the UK’s unemployment rate held steady at 5.2% over the three months to January. However, youth unemployment remains a key issue, with the number of 18- to 24-year-olds out of work and not in full-time education rising to its highest rate in over 10 years

• UK borrowing – Government borrowing rose to £14.3bn in February, well ahead of expectations of c.£8.8bn, according to the Office for National Statistics (ONS). Amidst rising borrowing costs, it was announced that borrowing was £2.2bn higher that in the same month last year. However, across the 11 months of the financial year to February, government borrowing is still down

• UK growth plan – Chancellor Rachel Reeves outlined the government’s mission to build a stronger and more secure economy, advocating a closer UK-EU relationship, a nuanced regional approach, and further investment in Artificial Intelligence (AI) innovation

• Germany – The ZEW Indicator of Economic Sentiment fell from +58.3 to -0.5 in March. The forward-looking survey, which gauges professionals’ optimism about the German economy over the next six months, has only fallen by more on two previous occasions, in March 2022 (beginning of Russia’s invasion of Ukraine) and April 2025 (Liberation Day)

• Japan – Large corporations are expected to offer a 5% pay increase to employees for the third straight year during the annual “Shunto” spring pay negotiations; a period during which unions simultaneously conduct wage negotiations with employers. The offer should ensure real wage growth for employees

• Alibaba – The Chinese e-commerce giant’s workforce shrunk by 34% in 2025 following the sale of offline retail businesses, Sun Art and Intime. Alibaba shifted its focus toward ramping up investments in AI. The company has set a target of $100bn in revenue from AI and cloud services over the next five years

• US inflation – The US Producer Price Index (PPI) rose +0.7% in February, higher than expectations of a +0.3% rise. On a 12-month basis, PPI inflation was +3.4%. The print suggests that inflation pressures persist away from rising energy costs too

Disclaimer

Past performance is not a reliable indicator of future returns. Nothing herein should be construed as a recommendation to hold, buy or sell any security or encourage any investment decision. The mention of any particular asset class, sub-asset class or company does not imply that it is held, or may ever be held, in any product or service.