The market reaction to one of the most highly anticipated UK budgets in recent years was always going to be closely followed. While the impact was some distance from the catastrophic mini-budget of 2022, there was still a degree of concern, surprise and unease among investors.
UK government bond yields actually eased heading into the UK budget announcement. The yield on the 10-year gilt dropped to 4.2% from the peak of 4.4% on Tuesday as Chancellor of the Exchequer Rachel Reeves began outlining £40bn of tax rises and plans to balance the budget deficit.
However, by the end of the speech, yields had reached 4.4% and had continued rising on Thursday, reaching 4.6% and the highest level since last year. On Friday morning, the 10-year gilt was still at elevated levels, trading at 4.5%. Meanwhile, the 10-year gilt-Bund spread reached 203 basis points on Friday, up from 194bp from the start of the month.
As well as a considerable amount of tax rises, the other headline from the budget was increased borrowing of £19.6bn this year and by an average of £32.3bn over the next five years. This is factored into the revised financing remit of the UK Debt Management Office, which will see an extra £19.2n raised via the gilt market over the course of the 2024-25 fiscal year.
This will bring total gilt sales to £296.9bn, the second-highest annual issuance by the UK DMO after Covid-19 in the 2020-21 financial year. Taking into account the fact there is no quantitative easing stimulus but rather £100bn worth of quantitative tightening over the next year by the Bank of England, this will be a record amount of gilts entering the hands of private investors.
Much of the extra issuance of gilts be tilted towards the long end, adding to the steepness of the curve. Meanwhile, there will be an extra £13.1bn of gilt sales via syndication during 2024-25 and one additional medium conventional syndication pencilled into the remit.
‘Higher borrowing can also push up the market cost of new debt issuances,’ said Moody’s in a report on Friday. ‘We expect financial markets to remain more sensitive to the potential for UK policy missteps, because of the gilt market turmoil that followed the September 2022 mini-budget.’
What will the Bank of England do?
While the extra issuance was slightly on the higher end of expectations, analysts say it was not the most significant contributor to the spike in gilt yields. ‘It’s not the increased issuance that is worrisome as much as the extra taxes, borrowing and spending that will boost inflation expectations in the short term,’ said Michiel Tukker, senior European rates strategist at ING. ‘We’re seeing quite a pro-growth and pro-inflation agenda, which means that the Bank of England’s policy rate will be kept higher for longer’.
A 25bp rate cut by the BoE is still expected at next week’s monetary policy committee meeting. But a further rate cut in December is now in doubt, as is the pace of rate cuts in 2025.
The Office for Budget and Responsibility expects consumer price index inflation to rise to 2.6% in 2025 compared to a previous forecast of 1.5%. Meanwhile, the OBR forecasts the economy to grow by just over 1% this year before rising to 2% in 2025.
‘At this stage, the end point for gilts is driven by how the BoE views this fiscal easing,’ said analysts at TD Securities. ‘The key risk is the outcome of the US election, which will be the driver for duration’. The analysts have put their year-end forecast for gilts between 3.9% and 4%.
Burhan Khadbai is Head of Content, Sovereign Debt Institute, OMFIF.
