Has the bond market turned on Rachel Reeves?

Less than three months after presenting her first budget, Rachel Reeves finds herself in treacherous fiscal waters as rising UK borrowing costs erode her room to lead.

Now, as the chancellor seeks to meet her self-imposed budget shortfall, there is growing concern that she may be forced to impose tighter fiscal policy in March, when the Office for Budget Responsibility presents its forecast.

The situation is bad for a Labor government, as Reeves said in her October speech. Fiscal statement He made a significant effort to “clean the slate clean” of the UK’s fiscal woes.

How was the UK thrown off course?

The central problem is constant took off Government borrowing costs, in the UK and around the world. The United States has been the main driver of global bond selling in recent months, partly on expectations that US President-elect Donald Trump’s tariffs will boost inflation.

But the United Kingdom was especially hit by the stress of fund managers Economy Continued inflationary pressures could lead to a period of “stagflation” that prevents the Bank of England from lowering interest rates to raise interest rates.

Coupled with an expected increase in debt sales following the Budget, fears of inflation have helped push the UK’s 10-year borrowing costs to the highest level since the 2008 global financial crisis and its 30-year borrowing costs to their highest this century. It also evoked a sense of weakness for Sterling.

Jim McCormick, macro strategist at Citi Investment Bank, said: “The pressure on both gilts and currencies suggests that the market is worrying about a UK recession or fiscal event.”

Why does this hurt so much?

Higher borrowing costs have direct consequences for Reeves’ budget plans, raising interest payments by more than £100bn a year.

In the year She has set a target of balancing the current budget by 2029-30, excluding investment spending. In October forecasts, the Office of Fiscal Responsibility, the Comptroller of the Budget proposed Reeves That year it met the law to save by a margin of £9.9bn.

But high interest costs are putting her goal in jeopardy. Long-term gilt yields have been rising steadily in recent weeks, with the 10-year gilt yield rising as much as 4.82 percent on Wednesday, the highest since 2008.

Ruth Gregory, economist at consultancy Capital Economics, said the moves seen so far were enough to more than wipe out the core of the current budget rules, with the Treasury now likely to breach the rule by £1bn.

This estimate is derived from market-implied expectations of the BOE benchmark interest rate and the 20-year gilt yield.

The Treasury said on Wednesday: “Meeting the budget is non-negotiable and there should be no doubt that the government will maintain a firm grip on public finances.” “Only an OBR forecast can accurately predict how much of a core the government has – anything else is pure guesswork.”

Do other factors affect public finances?

The OBR’s forecasts for March 26 set an improved growth outlook. GDP readings were weaker than expected at the end of last year and the BOE said the economy would not grow in the final three months of 2024.

The weak data leaves the OBR’s October forecast of 2 per cent economic growth in 2025 vulnerable, analysts said.

But the impact of GDP activity on credit will depend on whether the OBR decides whether the economy can bounce back to make up for the shortfall in parliament or whether there is a permanent deficit in output.

A downgrading of the OBR’s outlook for UK productivity and potential growth will do further damage to the Treasury and public finances.

What can Reeves do?

The decline in UK fiscal prospects comes as the government prepares for the next phase of the multi-year spending review, the results of which are expected in June.

The Treasury set the overall Whitehall departmental spending envelope in the October Budget, with day-to-day spending rising by 3.1 per cent in 2025-26 before a sharp reduction in real-time growth to 1.3 per cent in 2026-27.

Detailed plans are drawn up for the first year; The cost review is now looking at the coming years. They have authorities It is marked. If Reeves needs to adjust fiscal policy this spring, it’s likely to come with stronger spending plans than early tax hikes.

Because she promised to hold only one “fiscal event” every year, which will not be done until the autumn when the tax is changed.

Restoring the department’s spending plans below £10bn in October means curbing real-time growth by reducing day-to-day department spending from 1.3 per cent to less than 1 per cent, co-founder Ben Zaranko said. Director of the Institute for Fiscal Studies, a think tank.

But analysts fear that if the selloff in the bond market continues, Reeves may be forced to do more to shore up fiscal credibility. Such a move would likely result in tax hikes and front-loading spending restrictions, and not just promises of greater discipline in Parliament.

“Reeves may face a bad choice soon, either breaking her budget rules or announcing more tax hikes and/or spending cuts,” Gregory said at Capital Economics.

What other options are there?

The chancellor is looking to focus on a “pro-growth” narrative in the coming weeks, and that rapid economic expansion will pay dividends in terms of public finances.

Reeves is preparing to travel to China this week as she looks for ways to boost the economy.

But the prospect of a strong turnaround in GDP growth could easily be confounded. Investors have warned that attempts to lay a solid fiscal footing for the current parliament are at risk as the slide in government bond prices deepens.

Pooja Kumra, UK price strategist at TD Securities, said: “The sell-off has been flat since October, so Reeves has no place.

Data visualization by Keith Fray