UK borrowing costs have climbed to their highest level since the financial crisis, as gilts were caught up in a broad sell-off across global bond markets.

The UK government is set to pay a higher rate on debt interest after 10-year gilt yields — the benchmark for borrowing costs, influencing the pricing of mortgages, corporate loans and new government debt — rose by as much as 15 basis points. The yield reached an 18-year high of roughly 5.2 per cent, while longer-term gilt yields jumped to 5.9 per cent in early trading on Tuesday.

The UK experienced a sharper rise in borrowing costs than the US, Japan or Germany, reflecting heightened inflation fears stemming from the breakdown of trade across the Middle East. Gilt yields move inversely to prices, so the sell-off in government bonds translates directly into more expensive financing for the Treasury.

Kathleen Brooks, research director at XTB, said the worldwide jump in bond yields was driven by higher oil prices. The Brent crude benchmark hit $91 per barrel as tensions between the US and Iran deteriorated over the weekend, with new missile strikes exchanged by both sides.

Brooks noted that some market analysts believed the resumption of hostilities in the Middle East would be "short lived", although there were risks that disruption to trade could persist.

"We are now just two months away from the US mid-term elections, and President Trump shows no sign of scaling back the war in Iran to win votes, even though the conflict is not popular at home," Brooks said. "This could trigger volatility in the coming weeks, as investors fret that elevated oil prices could be here to stay."

Healey to be hit with '£6bn extra' borrowing cost

Panmure Liberum economist Simon French said the rise in 20-year gilt yields could hit John Healey's fiscal headroom by as much as £6bn.

That headroom — determined by fiscal rules requiring day-to-day government spending to match tax receipts by 2030 — stood at about £22.7bn based on fiscal forecasts drawn up before the Iran war. A squeeze of that scale would erode roughly a quarter of the chancellor's remaining buffer, intensifying pressure ahead of the next scheduled OBR forecasts, when the Treasury must decide whether to raise taxes, cut spending or loosen its rules.

The upgrade to debt interest payments in the Office for Budget Responsibility (OBR)'s forecasts would add to current projections showing the UK government will have to pay lenders up to £137bn in 2030.

Economists have suggested the Bank of England could respond by slowing the sale of bond holdings under its quantitative tightening (QT) programme — the process, begun in 2022, of unwinding the bonds accumulated during the post-2008 era of quantitative easing. Michael Saunders, adviser at Oxford Economics, said the Bank could ease the pace of QT from £70bn in the current year to £50bn to "limit upward pressure on gilt yields".

He said the programme could now focus on reducing the risks that higher interest rates pose to the Bank of England's balance sheet.

The Bank has maintained that the programme has had only a small impact on market pricing, but politicians from across parties — including Chancellor of the Duchy of Lancaster Louise Haigh and Reform UK's Richard Tice — have criticised the sell-off for costing taxpayers billions of pounds.

Analysts are largely split on whether the Bank's Monetary Policy Committee will raise interest rates later this year, with some economists still waiting to see how relations between Iran and the US develop over the coming weeks.

City analysts also warned that higher gilt yields would dampen the housing market in the short term. Capital Economics said the value of commercial property would be squeezed by higher borrowing costs, while RSM UK economist Thomas Pugh said a drop in mortgage approvals over July could mark the start of a difficult second half of the year for the housing market.

Pugh said a "combination of higher borrowing costs and lower disposable income is a toxic mixture for the housing market".