UK borrowing costs jump again on inflation fears over Middle East war

By Suban Abdulla

LONDON, March 5 (Reuters) - British government bond yields climbed sharply on Thursday and investors reduced further their bets on an interest rate cut by the Bank of England this month due to the surge in energy prices caused by conflict in the Middle East.

With analysts saying Britain appeared at risk from a pickup in inflation, yields on two-year gilts - which are sensitive to short-term interest rate expectations - rose by 10 basis points to a peak of 3.815%.

They fell by 2 bps on Wednesday but were on course for the biggest one-week rise since October 2024.

UK two-year gilts are the worst performing government bonds among the Group of Seven economies this month, with yields rising by more than 27 basis points. France and Germany are up by 21 bps.

"Concerns about the potential for an inflation crisis in the UK on the back of an energy price spike is playing out in the bond market and in the UK interest rate futures market," said Kathleen Brooks, research director at XTB.

Interest rate futures were pricing a one-in-four chance of a BoE rate cut this month and were fully pricing only one quarter-point reduction in borrowing costs during 2026.

Britain has the highest inflation rate among big, rich economies and is more reliant on imported gas and oil than many of its peers.

Analysts said the duration and scope of the war will be key considerations for the BoE's Monetary Policy Committee.

"If energy prices quickly fall back, it will probably resume easing, either in April or June," Michael Saunders, senior advisor at Oxford Economics and a former MPC member, said.

"Our new base case will still assume a second cut later this year. But if the surge in energy prices persists or expands, the MPC will be set for an extended pause."

The five-year British gilt yield jumped 10 bps to 4.035% while 10-year yields were up by a similar amount at 4.547% at 1413 GMT.

Thirty-year yields rose to their joint highest since February 13, also up by around 9 bps on the day at 5.246%.

(Additional reporting by Andy Bruce; editing by William Schomberg, Aidan Lewis)