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Bank of England set to step up the fight against inflation

Cost of borrowing: Short-term government bonds are more sensitive to a rise in the Bank of England's main interest rate

Bank set to step up inflation fight: Government borrowing costs jump as traders bet on aggressive rate hikes and increased government spending

Government borrowing costs jumped as traders bet on aggressive interest rate hikes and increased government spending.

Yields on two-year gilts — essentially the interest rate investors demand to lend to the government — rose to levels not seen since 2008 at 3.35%.

These short-term bonds are more sensitive to hikes in the Bank of England’s main interest rate, and yesterday’s jump signaled that investors expect Threadneedle Street to continue with exceptional rate hikes this week.

Cost of borrowing: Short-term government bonds are more sensitive to a rise in the Bank of England's main interest rate

Cost of borrowing: Short-term government bonds are more sensitive to a rise in the Bank of England’s main interest rate

The Bank has raised rates since December in a battle to rein in runaway inflation. Investors now expect a gigantic 0.75 percentage point rise to 2.5% tomorrow in what would be the biggest move in 33 years.

In a sign that traders expect the drastic action to continue, they forecast interest rates of 3.75% by Christmas.

While such a move could help reduce inflation, by encouraging saving rather than spending, it would increase the cost of debt for mortgage holders and other borrowers.

Britain’s ten-year gilts also hit their highest level since 2011 – hitting 3.32% – as Liz Truss argued for tax cuts in a mini budget on Friday.

With help on energy bills also underway, government borrowing is expected to increase.

The more the government has to borrow through gilts, the more investors will demand to receive returns.

The pressure on bond markets comes as the US Federal Reserve is due to announce its own interest rate decision today.

The Fed has been aggressive in its fight against inflation and is expected to announce another hike of 0.75 percentage points.

But it has put pressure on other countries to keep pace, as investors flock to the dollar.

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