The mercury has breached 40°C for the first time in British history, and the City of London is sweating. As climate records shatter across Western Europe, the government has called an emergency COBRA meeting. But while ministers fret about transport cancellations and health warnings, the markets are pricing in a different kind of crisis: the fiscal cost of a nation that is literally overheating.
Let me be clear. This is not a weather report. This is a market event. The immediate impact is on gilt yields, which have been under pressure all week as the heatwave compounds the Bank of England's inflation headache. A country that cannot keep its trains running or its workers cool is a country that cannot grow. And growth is precisely what we need to tame the inflation beast.
Consider the numbers. The UK's infrastructure was not built for 40°C days. Rail lines buckle. Runways melt. Power grids strain. Every cancelled train, every overheated office, every hour of lost productivity is a drag on GDP. The Office for Budget Responsibility will have to factor this into its next forecast. And with public debt already at 100% of GDP, the Treasury's room for fiscal stimulus is zero.
Meanwhile, the Bank of England faces a dilemma. Emergency rate hikes might cool the economy, but they will also increase the cost of government borrowing. The 10-year gilt yield has already risen 15 basis points this week, reflecting the growing risk premium. Investors are asking: does the UK have the fiscal resilience to withstand repeated climate shocks?
The COBRA meeting will discuss public health risks and transport contingency plans. But the real issue is capital flight. If foreign investors perceive the UK as a high-risk, low-growth environment, they will sell sterling and gilt assets. We have seen this before. The 2022 mini-budget chaos was a warning. This time, the trigger is not fiscal irresponsibility but climate vulnerability.
Let's not forget the inflation angle. Food prices are already up 10% year-on-year. A heatwave that destroys crops will only make things worse. The energy sector will also feel the heat, as air conditioning demand spikes. This is a supply-side shock that the Bank cannot solve with monetary policy.
Some will say I am being overly dramatic. But markets discount the future, and the future is looking hotter and more expensive. The UK's net-zero targets require massive investment in green infrastructure. That means more borrowing, more taxes, or both. The cost of capital is rising, and the window for action is narrowing.
In the short term, expect volatility. The FTSE 100 might rise on utility stocks, but the broader market will remain jittery. Sterling could weaken further, making imports more expensive and adding to inflation. The wise investor will hedge against climate risk. The foolish one will pretend this is just a hot summer.
The COBRA meeting is a political response. The market response will be harsher. The bottom line is this: climate change is not just an environmental crisis. It is a fiscal and monetary one. And the UK, with its ageing infrastructure and high debt, is particularly exposed.
Stay cool, but stay alert. The real heat is in the bond market.
