UK Borrowing Costs Rise Following Labour Government’s Budget Announcement
Market Reaction
The UK’s borrowing costs have increased for two consecutive days following the Labour government’s unveiling of a significant package of borrowing and tax hikes in its latest budget. Despite this, analysts believe that a second “mini-budget” crisis in the British bond market is unlikely.
Bond Yields on the Rise
The 10-year gilt yield, which represents medium-term borrowing costs for the government, reached 4.431%, up from around 4.3% ahead of the budget announcement. The 2-year gilt yield also rose from around 4.2% to 4.415%. Higher yields indicate a sell-off in bonds, suggesting that investors are becoming increasingly cautious about funding UK debt.
Tax Hikes and Borrowing Plans
Finance Minister Rachel Reeves announced a substantial increase in short-term borrowing, exceeding many economists’ expectations. The government plans to invest in public services and infrastructure, while also aiming to transition the budget towards a day-to-day spending balance. Although many of the plans were leaked to the public beforehand, traders remain on edge due to the UK’s recent history of volatile bond movements.
Economic Impact
Economists are divided on the impact of the budget on inflation and interest rates. Some believe that the fiscal expansion will lead to slightly higher inflation and a slower pace of interest rate cuts from the Bank of England, while others argue that the BOE will ease monetary policy at the same rate due to decreasing levels of services inflation. The Office for Budget Responsibility raised its near-term UK growth outlook but lowered its longer-term projection in a five-year forecast.
Investor Concerns
Susannah Streeter, head of money and markets at Hargreaves Lansdown, believes that the rise in risk premium for UK debt is not solely due 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,” Streeter said.
Pound Weakens Against Dollar and Euro
The British pound has declined against the US dollar and euro this week, although to a lesser extent than during the Truss mini-budget crisis. Sterling was 0.1% higher against the greenback on Friday morning, trading around $1.207.
Fiscal Concerns
Mohit Kumar, chief financial economist for Europe at Jefferies, expressed concerns about the UK’s fiscal outlook. “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.”
Kumar believes that the bond market moves are partly technical, but also driven by concerns about fiscal deficits and issuance globally. While he does not see a repeat of the 2022 mini-budget, he acknowledges that fiscal concerns are valid and could lead to higher bond yields in the future.
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