Investors take fright as gilt yields rise again after budget

Yields on UK government bonds rose to a fresh one-year high today as investors took fright at the government’s plans for £30 billion in extra borrowing in the budget and the prospect of interest rates being kept higher for longer.
Ten-year gilt yields, which are a proxy for the government’s borrowing costs, rose by seven basis points to a 12-month high of 4.48 per cent on Friday morning. They have been rising since after the budget on Wednesday. Yields on two-year gilts, which are sensitive to changes in the interest rate outlook, rose by 10 basis points to 4.48 per cent — a five-month high. Bond yields move inversely to bond prices.
Investors sold government bonds on the back of Rachel Reeves’s announcement of £70 billion a year in additional spending in her maiden budget that would be funded by £40 billion of tax rises and £30 billion in extra borrowing.
The pound also weakened sharply against the US dollar on Thursday which, alongside rising gilt yields, signalled that investor demand for UK government debt was tepid despite higher returns compared to other rich countries’ sovereign debt.
Stocks on the FTSE 100 fell by 49.53 points, or 0.6 per cent, to close at 8,110.10 on Thursday while the more domestically focused FTSE 250 was down 1.5 per cent, at 20,388.96. The pound declined by 0.37 per cent against the dollar to $1.291 and was 0.44 per cent weaker against the euro at €1.188. The pound and UK stock markets strengthened slightly on Friday morning.
Typically, rising government debt yields and expectations of high interest rates strengthen a country’s currency. The falling pound and rising bond yields were seen in the aftermath of Liz Truss’s mini-budget in September 2022, when sterling briefly hit a record low against the dollar and long-dated UK government bond yields surged. The dynamic underlines investor concerns about the outlook for economic growth and the credibility of fiscal policymaking.
The chancellor Rachel Reeves sought to reassure markets. She said “economic and fiscal stability” was the government’s main priority. “We have more headroom than the previous government left us, and that is important. We have now put our public finances on a stable and a solid trajectory,” she said in an interview with Bloomberg TV.
The UK’s Debt Management Office said the supply of gilts to the market would rise to just under £300 billion next year: an increase of £19.2 billion in 2024-25 and in line with market expectations. A higher supply of bonds pushes down existing bond prices.
Abbas Khan, analyst at Barclays, said gilts would come under further selling pressure as “heavy issuance will test the absorption capacity of the market, as well as the government’s resolve in delivering against its ambitious fiscal plans”.
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Shorter-dated gilts have also sold off over worries that the budget’s spending policies will lead to a temporary spike in inflation next year and prevent the Bank of England from carrying out significant interest rate cuts in 2025. The yield gap between UK ten-year gilts and equivalent bonds in the US and Germany widened on Thursday, reflecting the premium investors are charging to hold UK government debt.
James Smith, economist at ING, said the selling had been overdone as the inflationary impact of the tax rises and investment spending would be muted. “Gilt yields are too high internationally and falling inflation and a more doveish Bank should help to lower yields again. UK ten-year yields have risen above their US equivalents but that might not last long,” he said, in reference to the US presidential elections next week.
The Bank’s monetary policy committee is set to announce its latest interest rate decision next Thursday. Before Reeves’s budget on Wednesday, the central bank was anticipated to cut rates by 25 basis points from 5 per cent, although the likelihood of that has now diminished after the cash injection into the economy.
US bonds yields have also been rising in the past two weeks on the back of polls showing that Donald Trump is leading the race to become president. A Republican administration is likely to carry out major corporate tax cuts and impose tariffs on trading partners, lifting inflation and preventing the Federal Reserve from major monetary easing next year. Slower rate cuts by the Fed would support the dollar.