(Bloomberg) -- UK borrowing costs rose back to levels seen after last week’s budget announcement, in a sign of lingering investor anxiety over the government’s fiscal expansion plans and the US presidential election.
The yield on 10-year gilts climbed as much as eight basis points to 4.53%, slightly surpassing last week’s peak to reach the highest in a year. Short-dated rates also rose, outpacing US and euro-area peers, and demand for new bonds in an auction was the weakest in almost a year.
Bond investors are concerned that Chancellor Rachel Reeves’s plans to run up borrowing to boost investments will fuel inflation, limiting the Bank of England’s ability to cut interest rates. Gilts sold off sharply after the budget announcement and resumed losses on Tuesday amid broad market anxiety over the US election result.
“It’s a combination of US election uncertainty and concern about the budget,” said Mark Nash, head of fixed income alternatives at Jupiter Asset Management. “There seems to be some fear in the market that the budget won’t work.”
Earlier on the day, an auction of new 10-year gilts attracted the weakest demand since December, with bids totaling 2.81 times the £3.75 billion ($4.9 billion) on offer. That contrasts with solid investor interest for recent sales, including a 30-year green note offer last week.
It’s all a sign that investors aren’t willing to accept any hint of government largess when it comes to deficit spending. Last week, Wall Street veteran Ed Yardeni warned that “it’s a conceivable scenario that the bond vigilantes are definitely mounting up,” also referring to risks of increased spending in the US.
That’s a particularly sensitive topic in the UK, where the government is looking to sell the second-highest amount of bonds in the current fiscal year. The plans caused the yield on 10-year gilts to jump more than 20 basis points last week, reviving memories of former Prime Minister Liz Truss’ fiasco of a mini-budget two years ago.
Giles Gale, a strategist at UBS Group AG, also points to the structural shift in the UK bond market caused by pension funds buying fewer long-dated gilts. They were major buyers that have yet to be replaced, he said.
Election Risk
The losses in UK bonds were compounded by uncertainty around the US presidential election result. Many investors are sitting on the sidelines ahead of the outcome, which remains too close to call.
The concern is that US government spending will increase under either Donald Trump or Kamala Harris, though the risks are skewed higher under a Trump presidency. That would further lift borrowing costs with potential for global spillovers.
“Market focus is now squarely the US election, given the close race and potential market ramifications,” said Neil Mehta, portfolio manager at RBC BlueBay Asset Management. “Gilts are now taking a back seat.”
The vote will also set the stage for the BOE’s meeting on Thursday. Markets expect a quarter-point cut but have trimmed the scope for further reductions to account for looser fiscal policy. They now see between two and three additional reductions by the end of next year, compared to four before the budget.
“The fiscal loosening makes it harder for the BOE to accelerate cuts and to keep up with the pace of easing elsewhere,” Citigroup strategists including Jamie Searle wrote in a note. That means gilts are unlikely to rebound from recent losses, they added.
--With assistance from Alice Gledhill and Anchalee Worrachate.
(Updates with latest moves throughout.)
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