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UK borrowing costs rose on Wednesday, reversing an initially positive reaction to the Labour government’s Budget, as investors were surprised by the level of additional borrowing needed to fund Rachel Reeves’ plans.
The 10-year gilt yield rose to 4.37 per cent, a five-month high. The two-year yield was up to 4.34 per cent.
Yields on the 10-year bond had initially fallen to 4.21 per cent as Reeves delivered her speech, promising to “fix” Britain’s public finances and eliminate the government’s deficit on day-to-day spending in three years.
Analysts said the market was responding to an increase of borrowing of £28bn a year over the parliament, after what the Office for Budget Responsibility called “one of the largest fiscal loosenings of any fiscal event in recent decades”.
“It’s the amount of extra borrowing which is above and beyond what had been expected [that] has caught the market a bit unaware,” said Moyeen Islam, a fixed-income strategist at Barclays. “Going forward from here, it is still pretty challenging.”
The news came alongside fresh figures from the Debt Management Office showing debt sales were likely to reach £300bn in the current fiscal year, slightly above investors’ expectations.
The Budget was “gilt-negative”, said Citi’s Jim McCormick. Its initial market impact had been softened by the “prep work” done by the government signalling its plan to relax its fiscal rules and borrow more.
“If this had come out of the blue, it would have been viewed more negatively,” he said.
The OBR also said that the scale of extra borrowing had not been fully anticipated by investors and was likely to result in higher interest rates over the next few years.
Investors responded by scaling back their bets on rate cuts, with swaps markets now expecting three or four quarter-point rate cuts over the next 12 months. This pushed up the yield on rate-sensitive two-year bonds.
Andrew Pease, chief investment strategist at Russell Investments, said “large increases in government spending and the slower projected decline in public sector borrowing” were negatives for gilt investors.
Labour’s first Budget has been viewed as a test of investor appetite for the debt needed to fund its plans to “invest, invest, invest”.
Ahead of Wednesday’s announcement, the government had signalled it would relax its fiscal rules to target a different measure of debt that would free up room for extra borrowing.
That had fed investor anxiety over the level of gilt issuance over the coming years, causing a sell-off in recent weeks that has seen 10-year yields rise.
Small and mid-cap UK equities fared better than gilts, led by energy companies, after tax changes for oil and gas stocks were less negative than feared.
The FTSE 250 index climbed during Reeves’ speech, its biggest one-day increase since July.
“Do not underestimate how weak some smaller companies were going into this,” said Laura Foll, a portfolio manager at Janus Henderson. “The Budget provided certainty and it’s always certainty and clarity that people want.”