The first Budget Speech for a Labour Chancellor since 2010, so it’s important to sound confident. However, the market is alive to the use of the word ‘borrow’ in any budget speech, and it cropped up in Rachel Reeves’ first speech to parliament. This has important implications for the Gilts market and the UK economy.
Labour does not have an awful lot of room for manoeuvre as it seeks to plug a GBP 25bn deficit and honour pay rises across the UK public sector. Unfortunately, there are ‘choices’ to be made and to be fair, raising the standard of public services like health is an economic benefit – just one that is quite hard to measure by the usual statistical wonks.
But the choice made by the new government does not seem to be terribly pro-growth, which seems strange, given what it is saying. Forex analysts in the City now think that Reeves is being way more radical than people realise. That could feed through into both gilts and the GBP.
“I said in May that ‘Chancellor Reeves could be way more radical than we think,'” says Neil Wilson, an analyst with Markets.com. “Her Mais lecture laid bare a radical socialist agenda, more radical than anyone was prepared to acknowledge in the election campaign. Many in the City and the business world in general were won over by the Prawn Cocktail offensive 2.0, but a leopard, like gnarled former Labour chancellors, doesn’t change its spots so easy.”
Gilts were selling off again mid-week with the 10yr gilt yield up to 4.5% – the Chancellor will be watching this stuff nervously, even if we are still a way away from the kind of Truss-style moves that almost crashed the UK bond market in 2022.
Ratings agency Moody’s says the Labour budget’s plans to borrow more poses an ‘additional challenge’ to repairing the UK’s public finances, noting the higher cost of issuing debt and the limited headroom for absorbing shocks. Wilson himself thinks the Budget will inevitably require more tax hikes later in the parliament – to introduce austerity a couple of years before the next election is simply not a credible fiscal plan (as noted by Paul Johnson at the IFS).
Wilson’s own Budget Best Case: “The market sees the budget as being both pro-growth in the near-term (it cannot really price productivity gains 3+ years from now) and fiscally responsible. This would be the ‘buy the UK’ trade.”
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Three reasons to stay bearish on gilts after the UK autumn budget
Rising Inflationary Pressure: The budget poses inflation risks, with higher wages and National Insurance costs increasing labour expenses, especially in hospitality. GBP 100 billion in public investment could further drive inflation, worsen skills mismatches, and crowd out private borrowing.
Elevated Gilt Issuance: Gilt issuance rises to GBP 300 billion this year, plus GBP 94.9 billion over four years, raising sustainability concerns. Careful management is needed to avoid market disruptions and negative impacts on investor sentiment and pricing.
Fiscal Sustainability Concerns: Despite growth initiatives, the OBR’s lowered post-2026 forecasts suggest limited benefits. High borrowing and tight fiscal space raise concerns about economic shock resilience and borrowing costs.
Why Reeves needs to worry about rising Gilt yields
Gilt yields rose one day after the UK Autumn Budget, primarily because the announced budget implies a significant increase in government borrowing. Specifically, the Debt Management Office (DMO) has outlined plans for GBP 300 billion in gilt issuance for 2024-25, an increase of GBP 20 billion from previous estimates. This expanded borrowing requirement puts pressure on gilt prices, pushing yields higher as investors demand more return to absorb the growing supply of government debt.
“Looking ahead, there are compelling reasons to anticipate that Gilt yields may continue to rise,” explains Althea Spinozzi, who heads up fixed income strategy at Saxo. “Inflationary pressures stemming from the budget — such as higher minimum wages and increased employer National Insurance contributions — could prompt markets to expect a more cautious approach from the Bank of England concerning rate cuts. This mix of increased inflation risks and higher supply expectations is likely to exert sustained upward pressure on yields over the longer term.”
Rachel Reeves’ Nightmare Before Christmas: rising inflationary pressure
The budget introduces significant inflationary risks. For instance, large increases in the minimum wage and employer National Insurance costs will likely raise labor costs in many sectors, particularly low-paid service industries like hospitality. This could exacerbate wage inflation and lead to higher prices in these sectors, contributing to broader services inflation.
The planned GBP 100 billion in public investment over five years, though aimed at stimulating economic growth, may further fuel inflation in the medium term. Additionally, skills mismatches could worsen, driving up wages in certain sectors. This increased public investment could crowd out private sector borrowing and put upward pressure on interest rates.
Budget impact on Gilt issuance
The budget necessitates higher levels of gilt issuance, amounting to GBP 300 billion for the current fiscal year and an additional GBP 94.9 billion spread over the next four fiscal years. This significant increase adds to concerns about the sustainability of government borrowing.
The issuance strategy has shifted focus from short-term to medium- and long-term gilts, requiring careful management to prevent market disruptions. The DMO has planned to diversify issuance across various maturities and maintain a regular schedule of syndications and auctions, which could impact investor sentiment and the pricing of gilts.
Rising concerns over UK fiscal sustainability
While the budget aims for growth and investment, the Office for Budget Responsibility (OBR) has revised growth forecasts lower from 2026 onwards, suggesting limited long-term economic benefits from these measures. The fiscal rules, while providing a framework for stability, offer limited headroom, raising concerns about the government’s ability to respond to economic shocks without additional borrowing.
The upward revisions in future borrowing requirements suggest sustained high levels of Gilt issuance, which could increase the cost of borrowing for the government and potentially affect the broader economy.
Following the UK Autumn Budget, 10-year Gilt yields have broken through resistance at 4.35%, advancing to 4.43%, a level last reached during the autumn of 2023. The overall sentiment remains bearish, with yields showing potential to test the next resistance at 4.75%. If yields manage to break above this significant level — which aligns with the 2023 peak — they could extend their upward trajectory toward the 5% mark, a level not seen since before the 2008 Global Financial Crisis.
