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A sell-off in the gilt market intensified on Thursday, as investor worries over the additional borrowing set out in chancellor Rachel Reeves’ Budget pushed UK borrowing costs to their highest level of the year.
The yield on the 10-year gilt rose 0.17 percentage points to 4.52 per cent, while the two-year yield climbed 0.22 percentage points to 4.53 per cent.
The pound fell 0.8 per cent to $1.286 against the US dollar, its lowest in more than two months.
The moves followed volatile trading on Wednesday, when the bond market reversed an initially positive reaction to Labour’s first Budget in 14 years as the scale of the government’s additional borrowing became clear. Ten-year yields has fallen as low as 4.21 per cent as Reeves spoke.
“The Budget sounded OK with its well-flagged new fiscal rules . . . but the amount of extra borrowing in the future still caught the market by surprise,” said Michael Metcalfe, head of macro strategy at investment manager State Street.
“[It’s] amazing how the narrative can change in 30 minutes,” he added.
Analysts said the market was responding to an increase in 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”.
Figures from the Debt Management Office also showed debt sales were likely to reach £300bn in the current fiscal year, up from the previous estimate of £278bn and slightly above investors’ expectations.
“There’s a lot of risk-exiting that is going on,” said Moyeen Islam, a fixed income strategist at Barclays, saying investors were cutting positions ahead of a number of big events including US jobs data and the election. “There is nobody here to steady the market.”
Ben Nicholl, a senior fund manager at Royal London Asset Management, said the scale of the market move was partly down to bullish gilt investors rushing to sell their holdings, as well as a view that Reeves may further beef up gilt issuance in the near future.
“There is a fear, I think, that Labour will have to come back to the bond market in April, to increase borrowing and raise more taxes,” he said.
The surge in yields takes UK 10-year borrowing costs close to the 4.63 per cent peak seen in the wake of Liz Truss’s September 2022 “mini” Budget, which sparked a crisis in the gilt market. However, investors played down parallels with the Truss episode, when yields climbed by a third of a percentage point on the day of the Budget alone, and sterling crashed to an all-time low in the aftermath.
“There are no reasons for us to question the fiscal credibility in the UK,” said Pimco economist Peder Beck-Friis. “The government intends to bring the primary deficit into a large surplus, for the first time since the early 2000s.” Government debt “may not fall in coming years, [but] it is unlikely to rise dramatically either”.
Instead, investors pointed to comments from the OBR saying that the additional borrowing had not been fully expected by investors and was likely to result in higher interest rates over the next few years.
JPMorgan’s Allan Monks said Labour’s decision to “tax, borrow and spend on a large scale” would push up short-term growth and inflation.
He added that the Budget “changes the calculus” for interest rate cuts and increased the odds the Bank of England would proceed with quarterly cuts.
Swaps markets have moved to price in a slower rate of cuts over the coming year. Investors now expect three or four quarter-point rate reductions over the next 12 months. Before the Budget, they anticipated four or five.
UK stocks fell as traders pared back expectations of rate cuts. The FTSE 100 fell 1 per cent. The mid-cap FTSE 250, which is more domestically focused, was down 1.8 per cent having climbed 0.5 per cent in the previous session.
