(Bloomberg) -- A sharp selloff in UK bonds that sent borrowing costs to their highest in a year abated Friday as a weak jobs report in the US boosted demand for global debt.
After gilts initially slipped a third day in a rebuke of Labour’s plans for higher borrowing and spending, the bond market stabilized as signs of deterioration in American payrolls boosted the case for interest-rate cuts to support the world economy.
That left the yield on benchmark 10-year gilts at 4.45% — 21 basis points higher than five days ago. That’s the largest weekly rise since January, with both Moody’s Ratings and S&P Global painting a gloomy picture of the UK’s fiscal outlook.
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It’s hardly the reaction that Rachel Reeves would have wanted — or expected — for her first budget as Chancellor of the Exchequer. After signposting almost all of Labour’s big-spending budget in advance, there was little to rock markets in the announcement itself.
But projections from the Office for Budget Responsibility for higher inflation and fewer interest-rate cuts as a result of Labour’s plans, along with turbocharged bond sales to finance them, prompted a revolt in bond markets that quickly spread to stocks and the pound.
Reeves sought to reassure the financial markets on Thursday with a pledge of “economic and fiscal stability” in an interview with Bloomberg TV. Still, comparisons with the September 2022 gilt meltdown that followed then-prime minister Liz Truss’ botched mini-budget were unavoidable — particularly given Labour has sold itself as an antidote to the years of financial and political turmoil of previous governments.
“It seems the UK bond market is still caught in a case of ‘post-Truss stress disorder,’” said Stefan Koopman, senior macro strategist at Rabobank. “The second it’s faced with a bit of uncertainty and unfamiliar territory, investors are playing it safe: de-risk first, ask questions later.”
While the moves are much more contained this time round, they underline the gilt market’s fragility and show how little room for error Labour have as they try to revive the country’s sluggish economy.
UK’s Reeves Seeks to Calm Markets After Post-Budget Selloff
In its Friday report, Moody’s said the increase in borrowing, in part facilitated by a new measure of debt under the fiscal framework, would pose an “additional challenge” for already-difficult fiscal consolidation prospects in the UK.
That echoed a verdict from the independent OBR earlier this week, which described Labour’s plan as “one of the largest fiscal loosenings of any fiscal event in recent decades.”
Reeves’ measures unveiled on Wednesday included a £70 billion ($90 billion) annual increase in public spending and an extra £100 billion of expenditure on capital projects. Official projections suggest around an extra £142 billion of borrowing will be needed over the next five years as a result.
“Fiscal policy is now seen as a bigger risk to markets than monetary policy and the UK illustrated that this week,” said Chris Iggo, chair of the AXA IM Investment Institute. “Gilts are looking to be offering decent medium-term value at these yield levels, especially as the Bank of England will still be reducing interest rates, even if not quite as much as was expected before the budget,” he added.
BOE Outlook
Traders were left in doubt over whether the Bank of England will cut interest rates three or four times by December 2025, with policymakers set to meet next week and give their latest evaluation on inflation.
While a quarter-point cut is viewed as likely on Thursday, investors will be listening for any reaction to Reeves’ budget — and the market’s response — from BOE Governor Andrew Bailey.
“I’m a bit worried that if we do not see next week’s BOE meeting try to calm the market, you could see more non-domestic selling coming,” said Pooja Kumra, head of European rates at Toronto Dominion Bank.
The extra volatility from the UK comes at a sensitive time for markets as hotly contested US elections threaten price swings in Treasuries — and bond markets globally.
In Friday’s session, 10-year gilt yields climbed as much as six basis points to 4.51% before erasing that move to trade little changed at 4.45%. Two-year yields — up about 27 basis points on the week — were close to flat after surging the day before.
The path of yields from here will play a crucial role in whether Reeves can deliver the budget’s growth goals while also meeting the fiscal deficit rules, given the risk that higher borrowing costs erode her modest buffer.
“If yields keep rising the government will be under pressure to say how it would seek to restore some headroom,” said Sam Hill, head of market insights at Lloyds Bank.
--With assistance from Greg Ritchie.
(Updates with closing prices.)
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