UK Gilt Yields Surge Following Budget Announcement: Market Prepares for Inflationary Debt Increase
The UK budget announcement revealed a significant redefinition of debt, allowing the UK to borrow an additional $90 billion. This move has resulted in a surge in gilt yields, causing concern for another potential "minibudget" crisis.
Key Points from the UK Budget Announcement
UK Chancellor Rachel Reeves unveiled tax hikes amounting to £40 billion ($51.8 billion) and a significant increase in borrowing. These moves are part of Labour’s pledge to “rebuild” the UK, but they only offer modest projected boosts to growth and public spending.
The budget announcement was a crucial moment for both Reeves and Prime Minister Keir Starmer, defining their government. The scale of the budget was significant, with tax rises being the most substantial in at least 30 years. Reeves' narrative focused on Labour’s inheritance from the Conservatives, hinting at the likely battle lines for the next election, which is still five years away.
Reeves introduced tax hikes that will primarily affect businesses and the wealthy, arguing that she had no choice but to fill a fiscal hole left by her Conservative predecessors. To create the impression that the wealthy would bear the brunt of these changes, Reeves also decided to freeze fuel duty, increase the minimum wage, and end a freeze on income tax thresholds introduced by the Conservatives.
However, despite these significant tax hikes, Reeves’ intervention may still leave voters unsatisfied. Estimates by the Office for Budget Responsibility appeared to fall short of Labour’s manifesto pledge to have the highest growth in the Group of Seven, and day-to-day public spending will rise just 1.5% per year, with several government departments facing real terms cuts.
Inflation Forecast and Debt Management
The inflation forecast is a cause for concern. While the Bank of England’s mandate is reconfirmed as 2.0%, the Office for Budget Responsibility does not foresee this occurring until well beyond the end of the Bank of England’s forecast horizon. The risk is that UK inflation will not drop after 2025 but continue rising, potentially forcing the Bank of England to hike far sooner than expected.
Reeves also changed the debt measure targeted by the government for its other fiscal rule, which requires debt to be falling as a share of the economy. This change allows the government to borrow for investment. The government will now target public sector net financial liabilities instead of public sector net debt excluding the Bank of England.
Market Reaction to the Budget Announcement
The market's reaction to the Labour budget was swift and brutal. UK gilt yields soared as traders considered the long-term implications of taking on so much debt with a smaller than expected fiscal cushion. After dropping as low as 4.20%, the 10Y Gilt surged over 20bps higher, briefly touching 4.411%, the highest level since last November.
The rise in gilt yields suggests a market reassessing the Bank of England’s reaction function in the face of greater inflation risks. In other words, not only are the days of rate cuts numbered, but inflation may return much sooner than expected, prompting the next hiking cycle by the Bank of England.
After the announcement, the UK's Office for Budget Responsibility emphasized the fiscal loosening inherent in the budget, continuing the pattern of expansionary government policy in recent years. However, the bond market may have had its "lettuce" moment, and any incremental debt increases from here on out will only lead to a faster blowout in yields and lead to another debt crisis.
Bottom Line
The market is once again waking up to the likelihood that rates in the UK aren’t likely to fall as much previously expected, or the Bank of England would want. Should the blowout in yields continue, we may be just days away from another emergency QE action by the Bank of England. The only reason why the US can continue to borrow excessively is because it still has the world's reserve currency, although the recent surge in gold and bitcoin suggests that this might not last long. What do you think about this article? Share it with your friends and sign up for the Daily Briefing, which is every day at 6 pm.
UK Gilt Yields Surge Following Budget Announcement: Market Prepares for Inflationary Debt Increase
The UK budget announcement revealed a significant redefinition of debt, allowing the UK to borrow an additional $90 billion. This move has resulted in a surge in gilt yields, causing concern for another potential "minibudget" crisis.
Key Points from the UK Budget Announcement
UK Chancellor Rachel Reeves unveiled tax hikes amounting to £40 billion ($51.8 billion) and a significant increase in borrowing. These moves are part of Labour’s pledge to “rebuild” the UK, but they only offer modest projected boosts to growth and public spending.
The budget announcement was a crucial moment for both Reeves and Prime Minister Keir Starmer, defining their government. The scale of the budget was significant, with tax rises being the most substantial in at least 30 years. Reeves' narrative focused on Labour’s inheritance from the Conservatives, hinting at the likely battle lines for the next election, which is still five years away.
Reeves introduced tax hikes that will primarily affect businesses and the wealthy, arguing that she had no choice but to fill a fiscal hole left by her Conservative predecessors. To create the impression that the wealthy would bear the brunt of these changes, Reeves also decided to freeze fuel duty, increase the minimum wage, and end a freeze on income tax thresholds introduced by the Conservatives.
However, despite these significant tax hikes, Reeves’ intervention may still leave voters unsatisfied. Estimates by the Office for Budget Responsibility appeared to fall short of Labour’s manifesto pledge to have the highest growth in the Group of Seven, and day-to-day public spending will rise just 1.5% per year, with several government departments facing real terms cuts.
Inflation Forecast and Debt Management
The inflation forecast is a cause for concern. While the Bank of England’s mandate is reconfirmed as 2.0%, the Office for Budget Responsibility does not foresee this occurring until well beyond the end of the Bank of England’s forecast horizon. The risk is that UK inflation will not drop after 2025 but continue rising, potentially forcing the Bank of England to hike far sooner than expected.
Reeves also changed the debt measure targeted by the government for its other fiscal rule, which requires debt to be falling as a share of the economy. This change allows the government to borrow for investment. The government will now target public sector net financial liabilities instead of public sector net debt excluding the Bank of England.
Market Reaction to the Budget Announcement
The market's reaction to the Labour budget was swift and brutal. UK gilt yields soared as traders considered the long-term implications of taking on so much debt with a smaller than expected fiscal cushion. After dropping as low as 4.20%, the 10Y Gilt surged over 20bps higher, briefly touching 4.411%, the highest level since last November.
The rise in gilt yields suggests a market reassessing the Bank of England’s reaction function in the face of greater inflation risks. In other words, not only are the days of rate cuts numbered, but inflation may return much sooner than expected, prompting the next hiking cycle by the Bank of England.
After the announcement, the UK's Office for Budget Responsibility emphasized the fiscal loosening inherent in the budget, continuing the pattern of expansionary government policy in recent years. However, the bond market may have had its "lettuce" moment, and any incremental debt increases from here on out will only lead to a faster blowout in yields and lead to another debt crisis.
Bottom Line
The market is once again waking up to the likelihood that rates in the UK aren’t likely to fall as much previously expected, or the Bank of England would want. Should the blowout in yields continue, we may be just days away from another emergency QE action by the Bank of England. The only reason why the US can continue to borrow excessively is because it still has the world's reserve currency, although the recent surge in gold and bitcoin suggests that this might not last long. What do you think about this article? Share it with your friends and sign up for the Daily Briefing, which is every day at 6 pm.
