UK borrowing costs climb ahead of the budget; Water companies to pay £157.6m penalty for poor performance

UK borrowing costs climb as City braces for the budget

Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.

UK borrowing costs have been climbing in recent days as investors have braced for the budget in a little over three week’s time.

Traders have been selling UK bonds, known as gilts, which pushes up the yield (or date of return) on the debt.

As a result, the gap between UK and German borrowing costs has now reached its widest since summer 2023, and is appproaching the levels seen during the mini-budget panic of 2022…. as this chart shows:

A chart showing the premium on 10-year gilt yields over German bunds Illustration: LSEG

The yield on 10-year UK government gilts has now risen to 4.2%, its highest level since the general election three months ago.

Notably, that’s higher than the US – which pays around 4% to borrow for a decade – as well as Germany, where 10-year bunds yield just 2.2%.

Rising borrowing costs reduce the amount of headroom the government has to tweak tax and spending plans while still meeting its fiscal rules – to have debt falling in five-years time, and to balance day-to-day expenditure with tax receipts.

The City is anticipating that chancellor Rachel Reeves may adjust the UK’s fiscal rules, to give herself more headroom to fund investment projects. Such a move could lead to higher government borrowing than expected

Reeves must decide by Wednesday whether to do this, and potentially unlock up to £57bn in additional spending on infrastructure at this month’s budget.

Kathleen Brooks, research director at XTB, says “speculation is rising” that Reeves could change how the government’s fiscal rules are calculated to allow more spending on housing, roads and hospitals.

She explains:

The Labour government has promised that it would follow the Conservative’s fiscal rule, that public sector net debt should be falling in the fifth year of a forecast period. One way that the Chancellor could achieve this fiscal target at the same time as boosting investment, is to exclude losses on the Bank of England’s stock of bonds accumulated during quantitative easing from the government’s balance sheet. This could give the Chancellor up to £15bn of fiscal headroom.

Other plans being discussed include moving a national wealth fund away from the government’s books, which may also add another £15bn to the Chancellor’s fiscal headroom. The government is looking at ways to publish estimates of how much new capital projects will boost growth and generate money directly for the Treasury, which could also take the focus away from capital spending.

The agenda

7am BST: Gerrman industrial production data for August
8am BST: Kantar grocery inflation data for September
1.55pm BST: Redbook index of US retail sales

Key events

UK grocery inflation rises to 2%

In the supermarket sector, grocery inflation has edged up again, data provider Kantar has reported.

Supermarket prices are now 2% more expensive than a year ago, up from August’s 1.7%, according to Kantar.

Price rises drove shoppers towards discounts – sales of promoted items jumped by 7.4% over the month while full price sales rose by just 0.3%.

Fraser McKevitt, head of retail and consumer insight at Kantar, says:

“In the fiercely competitive retail sector, the battle for value is on.

“Supermarkets are doing what they can to keep costs down for consumers and thanks to their efforts the prices in some categories are falling.”

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The biggest increases in pollution incidents last year were reported by South West Water (80%), United Utilities (71%) and Northumbrian Water (65%).

Hafren Dyfrdwy is the only company to have met the performance commitment level for pollution incidents in 2023. It, and Southern Water, were the only two companies to commit fewer pollution incidents this year than last.

A chart showing water companies’ pollution performance Illustration: Ofwat

Ofwat says they are “disappointed” that water company performance on pollution incidents last year was the worst in the 2020-25 period to date.

It’s clear that the companies are failing to hit their own targets to reduce pollution. The sector committed to reducing total pollution incidents by 30% between 2020 and 2025 – today’s data shows they have only achieved a 2% reduction to date.

Here’s Mike Keil, Chief Executive of the Consumer Council for Water (CCW), on Ofwat’s report into the sector:

“Poor performance on pollution incidents and a failure to protect thousands of households from the misery of sewer flooding will do little to reverse the unprecedented decline in people’s satisfaction and trust in water companies, which is reflected in our research.

Customers will rightly question why some companies should be trusted with more of their money for future investment, when they are struggling to deliver on their existing commitments.

People need to see and experience changes which convince them the industry cares as much about the environment as they do. It’s one of the reasons why we’re working with water companies to help them develop a culture that puts their customers front and centre.”

James Wallace, CEO of campaign group River Action, fears that today’s penalties aren’t severe enough to force the water companies to improve their performance.

Wallace says:

“This might sound like a lot of money but frankly it is a drop in the ocean for polluting water companies that have handed billions in dividends and interest payments to investors.

“Clean and abundant water and healthy ecosystems are fundamental to human life and our economy.

“Yet, water companies continue to pollute the nation’s waterways without facing the full force of the law or sufficient penalties.”

Steve Reed: the public deserves better from water companies

Secretary of State for the Environment, Food and Rural Affairs, Steve Reed, says:

Our waterways should be a source of national pride, but years of pollution and underinvestment have left them in a perilous state.

“The public deserves better. That’s why we are placing water companies under special measures through the Water Bill, which will strengthen regulation including new powers to ban the payment of bonuses for polluting water bosses and bring criminal charges against persistent law breakers.

“We will be carrying out a full review of the water sector to shape further legislation that will fundamentally transform how our entire water system works and clean up our rivers, lakes and seas for good.”

Thames Water and Southern Water bottom for customer satisfaction

Customer satisfaction has continued to decline for most water companies in 2023-24, Ofwat’s report shows.

Only South West Water – Bristol region improved its customer satisfaction score in 2023-24.

Portsmouth Water, Wessex Water and Northumbrian Water had the highest ratings.

The largest percentage decline in scores between 2022-23 and 2023-24 were for Severn Trent Water, South West Water – South West region and SES Water.

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Southern Water and Thames Water remain the worst performers for the fourth year in a row.

Several companies cite operational and weather-related issues as reasons for declining performance, Ofwat reports.

A chart showing water company satisfaction ratings Photograph: Ofwat

No water companies are classed as ‘leading’

Ofwat has attempted to put the 17 water companies of England and Wales into three categories – ‘leading’, ‘average’ and ‘lagging behind’.

Depressingly (but not surprisingly), no companies qualify for the ‘leading’ rosette.

Three are lagging behind: Anglian Water, Dŵr Cymru, and Southern Water.

Four have been moved from ‘lagging behind’ to ‘average’: Thames Water, Yorkshire Water, South West Water – Bristol region and South East Water.

Thames’s promotion is a surprise, given the company is teetering close to defaulting on its debts, could run out of cash within months, has been placed in special measures, and might be nationalised.

Indeed, Ofwat admits it has “serious concerns about Thames Water’s performance despite this single year improvement in position”, which is why it placed the company in a Turnaround Oversight Regime in July.

Here are the key points from Ofwat’s annual report on the English and Welsh water sector:

Poor performance costs water sector £157.6m this year as companies fall further behind on some key Ofwat targets
Customers’ bills will be reduced to reflect these performance penalties in 2025-26, following end of period calculation
Ofwat CEO challenges companies to match record proposed investment with changes in company culture and leadership essential for lasting change
Despite water companies committing to reduce pollution incidents by 30 per cent, there has only been a 2 per cent reduction
Fewer companies categorised as ‘lagging behind’ but performance inconsistent across the sector

Water companies still failing on pollution and leakage

Damningly for the water sector, Ofwat reports there was an increase in pollution incidents for nine of the 11 water and wastewater companies in England and Wales in 2023.

After a year in which the industry failed to fix the sewage crisis, Ofwat CEO David Black explains:

Despite the sector committing to reduce pollution incidents by 30% in the 2020-25 period, and achieving a reduction of 15% from 2019 to 2022, the increase in pollution incidents in 2023 means there has now only been a 2% reduction to date.

On leakage, while progress has been made, companies have only achieved a reduction of 6% on an annual basis to date, against a target of 16% by 2025.

It’s a similar story with leaky pipes, Black adds:

On leakage, while progress has been made, companies have only achieved a reduction of 6% on an annual basis to date, against a target of 16% by 2025. The sector committed to reduce internal sewer flooding incidents by 41%, but four years in it has achieved a 10% reduction.

Water firms to pay back customers more than £157m after poor performance

Water companies in England and Wales are to pay a £157.6m penalty to customers after missing key targets on reducing pollution, leaks and supply interruptions.

Water regulator Ofwat has announced the move in its annual company performance report, which has also found that customer satisfaction has fallen to its lowest level since the measure was introduced in 2020-21.

Ofwat said the £157.6m rebate will be taken off bills for households and businesses in 2025-26.

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Presenting the report, Ofwat chief executive David Black warns that “there has never been a stronger case for a culture change in the water sector.

He says:

No company has made it into our ‘leading’ category for the second year running and progress against key targets, including pollution and internal sewer flooding, is unacceptably slow.

Black adds:

Companies’ failure to comply with responsibilities to deal with wastewater has already led to us proposing enforcement penalties on Thames Water, Yorkshire Water and Northumbrian Water totalling £168 million and investigations into the remaining wastewater companies in England and Wales are ongoing.