LONDON — U.K. borrowing costs are elevated after the Labour government unveiled a huge package of borrowing and tax rises in its Wednesday budget — but analysts downplayed the possibility of a second “mini-budget” crisis in the British bond market.
The 10-year gilt yield, representing medium-term borrowing costs for the government, was slightly lower on the day at 2:45 p.m. London time Friday. However, it was still above 4.4%, up from around 4.3% ahead of Wednesday’s budget. The 2-year gilt yield had risen from around 4.2% on Wednesday to 4.414% in the Friday session.
Yields move inversely to prices, so higher yields represent a sell-off in bonds — and an aversion to funding U.K. debt.
Along with around £40 billion in tax hikes, Finance Minister Rachel Reeves on Wednesday announced a significantly higher increase in short-term borrowing than many economists had expected. Reeves said the moves were necessary to transition the budget toward a day-to-day spending balance while investing in public services and infrastructure. Many of her plans reached the public in advance, bracing markets for impact.
But traders remain on-edge given the U.K.’s recent history with volatile bond movements, even though many macro conditions — most notably the significant cooling of inflation — are now different. Former Prime Minister Liz Truss was widely criticized in autumn 2022 for causing havoc in markets by announcing a huge increase in borrowing to fund tax cuts without any prior warning. The incident sent bond yields soaring so rapidly that they threatened to destabilize pension funds.
In notes analyzing this week’s budget, some economists have suggested that the scale of fiscal expansion announced by Reeves will lead to slightly higher inflation and a slower pace of interest rate cuts from the Bank of England; though others argue the BOE will ease monetary policy at the same rate, given lowering levels of services inflation.
Debate has also ensued about how much her policies will boost economic growth, a key aim of the Labour government. The Office for Budget Responsibility — a government-funded but politically independent body — raised its near-term U.K. growth outlook, but lowered its longer-term projection in a five-year forecast released Wednesday.
Beyond a near-term boost, the budget is unlikely to deliver significant growth benefits until after that five-year timeline, according to strategists at Deutsche Bank.
Susannah Streeter, head of money and markets at Hargreaves Lansdown, said the rise in risk premium for U.K. debt was not solely down to investor worries about an inflationary budget.
“It’s also this concern about just where all this extra investment spending will go and just how responsible the government will be in using that money. So, the risk premium has returned, to some extent, on the UK,” Streeter told CNBC’s “Squawk Box Europe” on Friday.
“It isn’t anything like we saw with the Trussonomics mini-budget when that spike really was high after those unfunded tax cuts came in,” she continued.
“It’s just this extra weariness that, you know, this is a big tax, this is a big spending budget [so] will government use prudence in executing its strategy? And I think that’s what bond investors want to see.”
Yields ease
Just as in the aftermath of the Truss mini-budget, the British pound initially declined against the U.S. dollar and euro, though not to the same level. Sterling staged a moderate rebound Friday and was 0.5% higher against the greenback, trading around $1.296.
Kyle Chapman, foreign exchange analyst at Ballinger Group, said that gilt yields were likely taking some cues from the U.S. on Friday, where bond yields initially fell after a weaker-than-expected jobs report appeared to boost the case for more aggressive Federal Reserve rate cuts.
Finance Minister Reeves will be relieved gilt yields eased from their highs on Friday, whatever the cause, Jane Foley, head of FX strategy at Rabobank, told CNBC.
“But they are still elevated and it may take several sessions before calm is properly restored” to U.K. asset markets, she told CNBC.
“If U.K. investors are taking some lead from U.S. markets, that may be signs that normality is returning, but it is possible that gilts and the GBP will remain on edge into next week’s BOE meeting and its latest set of inflation and GDP forecasts,” Foley said.
Global concerns
“The market is right to be concerned” about the U.K. fiscal outlook, Mohit Kumar, chief financial economist for Europe at Jefferies, told CNBC.
“We’ve had an expansionary budget [including] £70 billion in spending funded by tax raises. The point is, and a load of think tanks are questioning, whether the tax increases are going to give you as much money as you hope for, and it’s not obvious. That is a concern.”
“But second, the background is concerning on the fiscal side. We’ve got U.S. elections coming up, and the market is very worried about the U.S. election and what happens on the fiscal side… globally, people are getting concerned about fiscal deficit and issuance.”
Kumar said this week’s bond market moves were also partly technical amid a wash-out of “steepener trades” on the U.K., where investors profit from rising long-term yields relative to short-term yields.
“If inflation is higher, growth is higher, the Bank of England doesn’t need to cut so aggressively,” Kumar said.
While a continued sell-off in bonds would pose a danger, he said he did not see a repeat of the 2022 mini-budget.
That move was “very technical in nature,” when liability-driven investments were sensitive to the long-end of the curve, Kumar noted. “We think we are far away, at least 100 basis points far away [from that].”
He added, “But I think fiscal concerns are very much valid, and on top of it, if we get a Republican sweep [in the upcoming U.S. election] and we get more fiscal concerns, I think the bond market could still move higher in yields.”
— CNBC’s Sam Meredith contributed to this story
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