UK borrowing costs jump as Rachel Reeves’ spending plans unnerve investors

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UK borrowing costs climbed on Wednesday, reversing an initially positive reaction to the Labour government’s inaugural Budget, as investors were unsettled by news of higher than expected bond sales necessary to fund its spending plans.

The 10-year gilt yield climbed 0.05 percentage points to 4.37 per cent, a five-month high. The two-year yield was 0.08 percentage points higher at 4.34 per cent.

Yields had initially fallen as Reeves delivered her speech, in which she promised to “fix” Britain’s public finances and said she would eliminate the government’s deficit on day-to-day spending in three years, sooner than expected.

But markets reversed course after new figures from the Treasury published alongside the Budget showed debt sales of £300bn in the current fiscal year, up from the previous estimate of £278bn and slightly above investors’ expectations.

The Budget was “gilt-negative”, said Citi’s Jim McCormick. Its initial market impact had been softened by the “prep work” done by the government signalling its plan to relax its fiscal rules and borrow more, he added.

“If this had come out of the blue, it would have been viewed more negatively,” he added, highlighting surprises for investors such as the level of NHS spending.

Andrew Pease, chief investment strategist at Russell Investments, said “large increases in government spending and the slower projected decline in public sector borrowing” were negatives for gilt investors.

Labour’s first Budget has been viewed as a test of investor appetite for the debt needed to fund its plans to “invest, invest, invest”, without creating a sell-off similar to that following Liz Truss’s ill-fated 2020 mini-Budget.

Ahead of Wednesday’s announcement, the government had signalled it would relax its fiscal rules to target a different measure of debt that would free up room for extra borrowing.

That had fed investor anxiety over the level of gilt issuance over the coming years, causing a sell-off in recent weeks that has seen 10-year yields rise from around 3.75 per cent in mid-September.

Small and mid-cap UK equities fared better than gilts, led by energy companies, after tax changes for oil and gas stocks were less negative than feared.

The FTSE 250 index climbed as much as 1.7 per cent during Reeves’ speech, its biggest one-day increase since July, before paring back to trade up 0.5 per cent.

“Do not underestimate how weak some smaller companies were going into this,” said Laura Foll, a portfolio manager at Janus Henderson. “The Budget provided certainty and it’s always certainty and clarity that people want.”