UK borrowing costs hit post-election high on eve of Reeves’ first Budget

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The UK’s long-term borrowing costs hit a post-election high on Tuesday as investors braced for Rachel Reeves’ historic first Budget, when the chancellor will outline plans to raise tens of billions of pounds to invest in a push for growth.

Reeves will cast the Budget, which will also hit employers and the wealthy in one of the biggest tax-raising packages in history, as a defining moment. “This is not the first time it has fallen to the Labour party to rebuild Britain,” she will say.

The first female chancellor in the 800 years of the office will relax her fiscal rules to allow a wave of new borrowing — expected to top £20bn a year — for capital projects including hospitals, schools, green energy and transport schemes.

Investor anxiety over a rise in gilts issuance has added fuel to a sell-off in UK government bonds that pushed the 10-year yield up as high as 4.32 per cent on Tuesday, its highest level since June, before Labour swept to power at the July 4 UK general election. As recently as mid-September, the yield was about 3.75 per cent. Yields move inversely to prices.

Reeves has vowed to impose “guardrails” on her spending plans and to invest the extra money she borrows wisely on projects that promote long-term growth and fix Britain’s public services.

“The only way to grow economic growth is to invest, invest, invest,” she will say on Wednesday when she delivers Labour’s first Budget since 2010.

Reeves hopes that the markets will react calmly. How much of the expected £50bn of newly created borrowing headroom she uses should prove critical to how gilts react.

Some investors think the removal of political uncertainty could spark a relief rally. Orla Garvey, a senior portfolio manager at Federated Hermes, said the asset manager made a bet last week that gilts would gain after what she called a “Budget risk premium” fell away. 

Reeves’ claims that growth will be at the heart of her mission as chancellor will face an early test as the Office for Budget Responsibility issues its first set of growth forecasts under the new government.

The watchdog’s most recently published outlook envisages faster growth rates than are expected by many other leading forecasters, raising the risk that the chancellor is hit by downgrades on Budget day.

At 0.8 per cent, the OBR’s growth forecast for 2024 is below those of the Bank of England and City of London economists. But its prediction that GDP growth will leap to 1.9 per cent in 2025 and then 2 per cent in 2026 is more optimistic than projections from the BoE and forecasters polled by Reuters.

Reeves will compare her Budget to major Labour fiscal events in the past, including the 1945 postwar Budget and the Wilson government’s “white heat of technology” 1964 statement.

She will also draw parallels with the Blair government’s efforts to repair the country’s social fabric in the late 1990s. “The prize on offer today is immense,” she will say.

Apart from borrowing tens of billions of pounds extra over the parliament to invest, Reeves will also look to fill a £40bn funding gap for day-to-day spending, the large majority of that through tax rises.

The tax-raising package is needed to ensure Reeves meets her new “golden rule”, under which current spending must be covered by tax revenues. It is another attempt to persuade markets that she will keep a grip on the public finances and Reeves has said she will meet that objective within a “maximum” of five years.

Labour fought the general election promising only limited tax rises, but Paul Johnson, head of the Institute for Fiscal Studies think-tank, said it was shaping up to be “one of the biggest tax raising Budgets in history”.

An expected £20bn rise in employers’ national insurance contributions will be the single biggest tax increase, while capital gains tax on shares will rise alongside higher taxes on non-doms, private equity bosses and private schools.

The chancellor is confident the tax rises will not cause a significant exodus of millionaires from Britain, according to people familiar with her thinking. One senior government official said some might be pleasantly surprised: “People always tend to expect the absolute worse.”

A freeze in income tax thresholds beyond 2028 is also expected by government officials, raising about £7bn a year. Reeves will promise to protect “working people’s payslips” but the move is seen as a “stealth tax”.

Reeves will blame the tax rises partly on what she claims was a £22bn “fiscal black hole” left behind by the Conservatives, a figure hotly contested by former chancellor Jeremy Hunt.

The OBR will assess the veracity of Reeves’ £22bn claim in a special report to be published alongside the Budget. In recent days Hunt has expressed fury that it will be used as “a political weapon” against him.

Reeves’ statement comes almost four months after Labour’s election victory and some ministers privately admit the wait has been too long and has contributed to a sense of drift.

In the intervening period Prime Minister Sir Keir Starmer has been accused of being too gloomy about the economy, triggering a fall in consumer confidence and a collapse in his own personal ratings.

A survey by More in Common found Starmer’s approval ratings fell from plus 11 in August to minus 38 in October. A “word cloud” by the same polling group asked people what they felt about the impending Budget and “worried”, “nervous” and “scared” featured prominently.