(Bloomberg) -- UK bonds fell as investors were unnerved by the government’s plans to fund investment and stimulate the economy, which could mean interest rates stay higher for longer.
The yield on two-year bonds jumped as much as 13 basis points after the Debt Management Office announced £297 billion ($386 billion) of government bond sales in the fiscal year. While that was only slightly higher than expectations, investors pointed to official projections that imply around an extra £142 billion of borrowing over the next five years.
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Traders adjusted for this looser fiscal policy by scaling back bets on monetary easing by the Bank of England. The market is now pricing just one more interest-rate reduction for the rest of the year, compared with two before Chancellor of the Exchequer Rachel Reeves’s announced her budget.
“Today’s budget was in fact a big fiscal loosening,” said Shaan Raithatha, a senior economist at Vanguard Europe. “We expect inflation and the BOE interest rate to fall more slowly as a result of today’s announcement, as stronger growth in the short run exerts upwards pressure on core inflation.”
The extra issuance will add to a debt pile that has ballooned in recent decades to around 100% of gross domestic product, putting pressure on a market that is already trailing major peers. Inflation in the UK is proving stickier, and the BOE is seen cutting borrowing costs at a slower pace than the Federal Reserve and European Central Bank.
The yield on 10-year gilts on Wednesday climbed above 4.4%, its highest in almost a year. The move later pared as some investors took the opportunity to lock-in higher rates. The volatile session saw the yield trade in an over 20-basis-point range, the most since March 2023, with investors closing out and re-entering positions exacerbating the moves.
In her budget, Reeves also changed a debt measure targeted by the government in its fiscal rules — which requires debt to be falling as a share of the economy. That gives her more space to borrow for investment.
Gilts will “struggle to fully unwind the ‘Budget premium’ built up over recent weeks,” said Matthew Amis, an investment director at abrdn. “The extra long gilt issuance is catching the market off-guard.”
Alongside the gilt sales, the DMO said short-term treasury bills will provide a net contribution of £3 billion to the government’s financing needs. Banks surveyed by Bloomberg had estimated around £6 billion.
The new plan tilted sales slightly toward longer-maturity bonds, though short- and medium-dated paper still forms the bulk of issuance. While this initially resulted in the yield curve steepening, the move soon reversed.
“I’m a little bit surprised at the selloff and it’s front-end driven as you can see,” said Orla Garvey, portfolio manager at Federated Hermes, who is long gilts versus bunds. “There were more longs than were expected and this move obviously is isn’t in keeping with that.”
A forecast from the OBR sees almost £30 billion higher cash requirements in the next fiscal year compared to its forecasts from March, with increases also seen through the current decade.
“Today’s Budget signals a lot more gilt issuance to come, relative to previous expectations,” said Sanjay Raja, chief UK economist at Deutsche Bank. “In the end, markets will have to grapple with higher borrowing.”
--With assistance from James Hirai and Alice Gledhill.
(Updates throughout.)
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