UK government borrowing costs have risen above 5% amid an intensifying global bond market sell-off fuelled by the Iran war.

The yield – or interest rate – on 10-year debt hit its highest level since the 2008 financial crisis, rising 13 basis points to 5.081%, as investors acted on concerns about the economic fallout from the conflict.

Borrowing costs also rose for the US and eurozone governments, underscoring growing turbulence in the global financial system after Donald Trump’s extension of a deadline for a peace deal failed to soothe jittery investors.

Financial markets worldwide slumped on Friday, extending falls seen since the outbreak of the war, with losses in London and across major US and EU trading hubs. The price of Brent crude remained above $110 a barrel.

Kathleen Brooks, the research director for the UK at the financial trading platform XTB, said: “Markets feel more panicky this week, and Friday’s price action suggests that investors are losing faith in Donald Trump’s ability to end this war and reach a deal with the Iranians.”

As the US-Israeli war enters its second month, the pressure in markets reflects concern about an inflation shock triggered by the surge in energy prices amid the effective closure of the critical strait of Hormuz.

Economists have said that given the reliance of the British economy on global trade and its sensitivity to oil and gas price rises, it could be damaged more than the economies of other industrialised nations by the Middle East conflict.

City traders are betting the Bank of England could be forced to raise interest rates more aggressively than in the US or the eurozone to prevent stubbornly high rates of inflation from taking root, despite fears over the strength of the economy and a slowdown in the UK jobs market.

Financial markets are pricing in at least two interest rate rises in 2026 – contributing to the leap in government bond yields, which are sensitive to inflation and interest rate expectations.

The increase in borrowing costs will add to the challenges facing Rachel Reeves, the chancellor, amid pressure on Labour to provide a package of financial support for households already reeling from a cost of living crisis.

Economists have warned that the Bank could be forced to take a tough approach to tackling inflation after losing some of its credibility by underestimating the leap in inflationary pressures in 2022.

The Bank was heavily criticised for its response to the inflation shock after the Covid pandemic and Russia’s full-scale invasion of Ukraine, when the headline rate peaked above 11% in October 2022, the highest level in four decades. Threadneedle Street then raised interest rates 14 times in a row.

Some economists have questioned whether the Bank could have done much differently, arguing that a sharper rise in borrowing costs would have done little to restrain the energy price shock while tipping the UK into a deep recession.

Experts have suggested that the central bank could “look through” the latest energy price surge, warning that the fallout from the Middle East conflict is hitting the UK economy at a moment when it is substantially weaker than in 2022, with slower growth and rising unemployment.

On Friday a survey by the National Institute of Economic and Social Research showed that several leading experts, including former Bank insiders, believed that stubbornly high inflation risked becoming entrenched amid dwindling trust in Threadneedle Street to hit its 2% target.

“Overall, the panel favoured a tighter interest rate path in the UK, with credibility being cited as a contributing concern,” the thinktank said.

Charlie Bean, a former deputy governor of the Bank, said its monetary policy committee (MPC) had taken the right approach to hold interest rates unchanged at 3.75% last week amid elevated uncertainty over the fallout and duration of the Iran conflict. However, he said the damage to its reputation could force it to err on the side of caution.

“As there is a perception that the Bank was a little tardy in tightening policy back in 2022-23, it is important that MPC are vigilant and act promptly if needed this time around in order to reinforce the committee’s credibility,” he said.