Government Borrowing: Myths and Realities of Bonds

“Don’t spook the bond markets.”

June 2026

Whenever anything out of the ordinary is suggested for the economy, the cry goes up “We mustn’t spook the bond markets”, because they provide the money the government borrows, and, if they are unhappy, they will charge higher interest (or “yield”).  This has come up again with the change of leadership – Andy Burnham has said that we should not be ruled by bond vigilantes, and then rowed back on his statement.  But it must be wrong for unelected financiers to decide government policy, so how did we get here and how much in hock are we?

Let’s begin with how the government pays for things.  It’s a complicated business, but essentially they create the money and then “spend it into the economy.”  So why the need for borrowing (or taxes for that matter)?  Neither actually pay for anything directly, but taxes help to prevent inflation and bonds help to oil the financial machinery.  The government “borrows” from all sorts of places (including you if you have premium bonds or national savings), but, like a bank, it is essentially providing a safe place to deposit savings, and banks, pension funds and the like need that.  So they don’t issue bonds out of desperation for money, but as a service to the financial sector, with minor benefits to itself in its daily financial business.

The interest rate paid on bonds is not decided by the investors, but is based on the Bank of England’s base rate, with small variations. Indeed, the government doesn’t have to agree the yield asked for, and could withdraw their offer if they felt they were paying too much interest, or the Bank of England could buy at its own proposed rate, as it did with Quantitative Easing.  The Neoliberal mindset assumes that the financial institutions have the government over a barrel, but in fact the government holds all the cards (forgive the mixed metaphor).  The idea that the vigilantes were in control largely came about after the Kwarteng budget and the Bank of England’s Quantitative Tightening did spook the pension funds for technical reasons and led to a sense that the government was beholden to a bond-dealing mafia, rather than just being a cock-up.

So, suppose the bond vigilantes decided the new government couldn’t be trusted with the economy, they would value bonds at a certain level below the market price, and so demand higher yields for investing.  This may be seen as enforcing fiscal discipline on a profligate government, but it’s just a speculative punt by financiers looking for a profit, as they always will.  If the said government ignored them, the roof would not fall in, and it would probably call on the Bank to intervene as it did in 2009. If there is a financial crisis, the bond market is not the place to look for a solution.  Fear of the vigilantes is an entirely political concoction.  Both sides have a vested interest in things running smoothly, and, as is always said, the one thing markets hate is uncertainty.

AH