The Honest Economy Issue #2: UK Borrowing Costs Are Rising. Here's What That Means for Your Business.

Political uncertainty in the UK has pushed borrowing costs to levels not seen in over a decade. UK 10-year gilt yields are now sitting above 5%. That’s higher than the US, higher than Germany, and still climbing. For most business owners, "gilt yields" sounds like something that lives behind a Bloomberg terminal. But the reality is that it isn't. It's a number that will show up in your loan repayments, your supplier invoices, and your cash flow. It can affect your business both directly and indirectly through methods you wouldn’t of thought about.

Here's what's happening, and what you should be thinking about right now.

When a government needs money, whether that is to fund public services, pay existing debts, or cover a budget shortfall, it isn’t as simple as just asking the Bank of England to print money. It requires looking for the money that is already flowing within the economy itself. And it does this by borrowing from investors (both individuals and corporations) by issuing what's called a government bond (in the UK, these are called gilts). This is effectively the government looking for a loan from the public. The government takes the money, promises to pay it back over a set period, and pays interest along the way. Exactly the same as an ordinary loan structure.

The interest rate, from the investor's perspective, is actually called the yield. And like any loan you've ever taken out, the yield reflects risk. The more confident an investor is that they'll be repaid, the lower the yield they'll accept. The less confident they are, the more interest they will demand in return for the risk they're taking on. When it comes to a government bond, this risk is reflected as a state of the country’s stability and economy.

Right now, investors are demanding more than ever before. Gilt yields are rising because the confidence in the UK's political and fiscal stability is falling fast. It is essentially the bond market's version of questioning the country’s stability and future.

Here's where it gets practical to the business owner. The government's borrowing cost sets the floor for borrowing costs across the entire economy. Banks don't lend to businesses at less than the rate the government pays. This is because the government’s borrowing interest rate is what is believed to be the “risk-free” rate, effectively the rate the markets believe the return should be that has no risk attached to it.

Thus the banks will lend with a margin on top of the risk free rate. When gilt yields go up, the cost of borrowing across the nation will inevitably go up. If the bank believes they can earn a higher interest return from the government which is risk-free, then why would they take on a higher risk for a lower return elsewhere.

If your business carries debt, whether it be an overdraft, a revolving credit facility or a variable rate loan, the interest rate on that debt is likely to increase. This is not hypothetical, it's already moving in that direction. Any debt that is currently on a fixed term contract won't feel it immediately, but anything without a fixed term is exposed greatly to increased repayments on interest.

This is a good moment to pull out your balance sheet and look honestly at your debt structure. What proportion of your funding is debt-based? What's fixed versus variable? For the next few months, while political uncertainty plays out, there's a case for leaning on retained earnings for short-term investment and funding rather than taking on new debt or drawing down variable facilities. It's not a permanent strategy, but used wisely, it can be a sensible hedge whilst the uncertainty still lingers in the government.

There's a secondary effect that doesn't make headlines but hits your finances just as hard.

Pound Sterling is weakening.

Under normal circumstances, rising yields should actually attract foreign investors. They buy pounds to purchase gilts, and the currency strengthens. After all, when the yield climbs above other countries, wouldn’t you want to invest more money with them given the return has no risk attached to it?

But what's happening now is entirely different and actually more concerning. Yields are rising AND the pound is falling at the same time. That's the market telling you the country is currently facing a confidence crisis. All types of investors aren't piling in but pulling back.

For any business that imports goods or materials from outside the UK, this is a direct cost increase that isn’t directly and easily visible on your financials. A weaker pound means you're paying more for the same goods, even if the supplier hasn't changed their prices. Most businesses don't account for this. They don’t even model in assumptions that drove the FX impacts on costs. They always accept the hit without realising the true extent of the damage, then wonder why margins might have become this tight. The concept might be understood in theory to many, but the true financial impact is only assessed by a few.

If your business depends on imported goods and you have flexibility on timing, it may be worth pausing non-urgent import purchases until the FX volatility settles. For those who must import, now is the time to build a basic currency impact model. Tracking GBP fluctuations against your major import costs can surface how much exchange risk exposure you're actually carrying.

The common thread across all of this is debt. Debt funding is the primary lever that gets pulled when borrowing costs rise. Businesses with high debt exposure, particularly those that are borrowing on variable rate loans, are the most vulnerable to what's unfolding.

The action isn't to panic. It's to review carefully.

Look at your debt ratio. Understand which of your facilities are rate sensitive. Consider whether short-term investment decisions can be funded through other forms such as retained earnings, rather than from new borrowing. Model your FX exposure if you're importing. It requires an honest look at your numbers while there's still time to act early rather than react when it becomes too late.

The bond market has started shifting to convey a very strong message to the economy. Now is the time to listen and make the right decisions.