UK borrowing costs soar day after Labour government unveiled tax-raising budget

Key Points

• U.K. bond yields spiked sharply Thursday after the ruling Labour Party unveiled its debut budget.
• Yields had already risen on Wednesday shortly after the budget announcement by Finance Minister Rachel Reeves, which contained plans for £40 billion ($52 billion) worth of tax hikes and committed to substantially higher borrowing in the coming years.

LONDON — U.K. bond yields spiked sharply Thursday after the ruling Labour Party unveiled a sweeping package of tax hikes and increased borrowing.

The 2-year gilt yield was 13 basis points higher at 4.436% at 4:50 p.m. in London, after jumping more than 20 basis points earlier in the session. The 10-year yield was 10 basis points higher, at 4.457%.

Yields had already risen on Wednesday shortly after the budget announcement by Finance Minister Rachel Reeves, which contained plans for £40 billion ($52 billion) worth of tax hikes and committed to substantially higher borrowing in the coming years.

Yields move in the opposite direction to prices.

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"What immediately stands out is just how much borrowing is projected to rise over the next few years," analysts at ING said in a note in response to rising yields on Wednesday.

"We've argued for some time that the government had little choice but to raise real-terms spending. But what has been delivered is undoubtedly higher than many had expected just a few weeks ago."

The analysts cited the independent Office for Budget Responsibility's forecast that borrowing will be on average £36 billion higher each year over the next five fiscal years, given the time it will take for the additional tax revenue to come through.

Despite the big moves this week, the gilt market is remaining relatively stable compared to September 2022, when the U.K. suffered its so-called "mini-budget crisis."

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At the time, former Prime Minister Liz Truss of the Conservative Party announced billions in unfunded tax cuts, leading to bond market swings so severe that they threatened to destabilize U.K. pension funds and required emergency intervention from the Bank of England. Truss was forced to reverse the majority of the changes and resigned within weeks.

Analysts had said ahead of the October 2024 budget that such bond market volatility was unlikely to repeat itself, largely because the U.K. inflation has dropped sharply since the Truss era. The latest headline print was 1.7% versus 10.1% during Truss's premiership, which economists said would make markets more tolerant of fiscal expansion.

These stocks are likely to gain from the UK’s major budget announcement, analysts say

Some have since said that Reeves' budget is likely to prove mildly inflationary, and may lead the Bank of England to cut interest rates at a slower pace than previously thought. Analysts at Goldman Sachs said Thursday it would "reduce the urgency for sequential cuts in the near term."

"[The budget] is probably going to raise our forecast for growth in the U.K. over the near-term, but it could also provide a little bit of upward pressure on inflation," Morgan Stanley's global head of corporate credit research, Andrew Sheets, told CNBC on Thursday.

The ING analysts nonetheless said they thought the BOE would not change course based on the budget, given that services inflation, one of their key watch-points, was likely to continue to fall.

The British pound — which plunged to an all-time low against the U.S. dollar in the aftermath of the mini-budget — was on Thursday 0.4% lower against the greenback at $1.2908. Sterling was meanwhile down 0.46% against the euro.

In a note released early Thursday, Deutsche Bank strategist Jim Reid said the market reaction to the U.K. budget "probably wasn't helped by strong European data pushing up yields on the continent," along with "general upward pressure on U.S. yields as [Donald] Trump looks to have generally improved his standing in the polls in recent weeks."

He noted that the Wednesday budget "was probably two-thirds of the Truss mini-budget in terms of a fiscal easing," but that the higher borrowing is planned in order to increase investment rather than fund tax cuts.

Those investments "aren't expected to bear fruit in growth terms until after the 5 year time horizon," Reid added.

Stefan Koopman, senior macro strategist at Rabobank, said the budget would stimulate growth on a net basis, "especially compared with previous plans."

"We think the Bank of England will also have an eye on its impact on supply, allowing them to 'look through' this budget as much as possible. The Bank is already on a path of gradual easing and there is no need to unnecessarily complicate that picture," Koopman said.

— CNBC's Ganesh Rao and Karen Gilchrist contributed to this story