UK gilts under relentless pressure as Iran war intensifies

By Andy Bruce

MANCHESTER, England, March 20 (Reuters) - British 10-year government borrowing costs soared past 5% for the first time since the global financial crisis almost 20 years ago on Friday, as the Iran war escalated and compounded investor unease over Britain's vulnerability to rising energy costs.

The 10-year gilt yield GB10YT=RR, which moves inversely to the price, rose to 5.02% at 1444 GMT, up 17 basis points on the day, hitting its highest level since July 2008, according to LSEG data.

Short-dated gilts suffered even more severe losses after one of the biggest one-day price drops on Thursday since modern records began, which was accelerated by rising expectations of Bank of England interest rate hikes.

The 2-year yield GB2YT=RR was up 21 basis points at 4.613%, after a 30 bps rise on Thursday.

U.S. officials told Reuters on Friday that thousands of additional troops were being sent to the Middle East. Earlier, Iran attacked an oil refinery in Kuwait and Israel killed a spokesman of Iran's Revolutionary Guards.

"Another blockbuster week in the gilt market," said Matthew Amis, investment director at Aberdeen, in a note to clients, listing the surge in energy prices, hawkish language from the BoE and pressure on the government for new cost-of-living measures that would stretch the public finances.

"One of these things happening would be enough to get the gilt market nervous, but when you get all three in one day the result is 10-year gilt yields heading for ... 5%."

Britain's domestic energy price cap is forecast to rise by about 20% in July, analysts at Cornwall Insight said on Friday.

Britain's heavy reliance on imported natural gas and stubbornly higher inflation have driven a far bigger slump in its government bonds than that seen among international peers.

"There is great uncertainty about the inflation outlook. This hits the UK at a time when the UK has had a greater sensitivity to global shocks," said Chris Scicluna, head of research at Daiwa Securities in London.

"I don't think the central banks will be intervening in these bonds markets. It's not that we are looking at demand for gilts drying out. But the UK government is going to have to pay a higher rate."

Britain's government borrowed a lot more than expected in February, in part due to the erratic timing of debt interest payments, data showed on Friday.

Investors priced in 87 basis points of BoE rate hikes for this year - or three quarter-point increases - a big reversal from only two weeks ago when two rate cuts were priced in.