By William Schomberg
LONDON (Reuters) – Rachel Reeves is facing her first major test as Britain’s finance minister after the government’s borrowing costs climbed for a third day on Thursday and the pound’s losses deepened, potentially forcing her to cut future spending.
The Treasury said late on Wednesday that it would maintain “an iron grip” on the public finances after a selloff in debt markets on Tuesday and Wednesday that pushed the yield on 30-year British government bonds to a 26-year high.
Gilt yields rose again on Thursday – albeit less sharply than over the previous two sessions – and the pound was headed for its biggest three-day drop in nearly two years.
The fall in the value of the pound along with the heavy sales of government bonds prompted some comparisons with the 2022 “mini-budget” crisis that forced former prime minister Liz Truss out of Downing Street.
However, this week’s market moves have been less sharp and there has so far been no evidence of the kind of strain on institutional investors that forced the Bank of England into emergency bond purchases in 2022.
Treasury minister Darren Jones told parliament the UK bond markets “continue to function in an orderly way. Underlying demand for the UK debt remains strong.”
PIMCO, one of the world’s largest bond investors, said it was still positive about UK government bonds and much of the move was being driven by shifts in the U.S. bond market ahead of Donald Trump’s presidency.
“Although UK-specific factors, such as the budget, have contributed to the rise, most of the increase has been driven by rises in U.S. Treasury yields during the same period,” PIMCO economist Peder Beck-Friis said.
The new British government launched its plan for more investment in public services and infrastructure to boost economic growth just days before Trump’s Nov. 5 election victory which pushed up in borrowing costs globally.
That shift in markets has made investors more worried about the combination of high borrowing in Britain planned by Reeves and Prime Minister Keir Starmer, and the impact of their higher taxes for business on an economy that is now stagnating.
A survey of recruiters on Thursday showed that vacancies slumped in December, while in Britain’s Marks & Spencer (OTC:) and other retailers fell due to concerns about weak consumer confidence.
Analysts at Citi said the market reaction to the budget had been “a slow burn” until now but British bonds were being hit by worries about the extent of the government’s borrowing plans, which could keep pressure on inflation and prevent the Bank of England from cutting interest rates quickly to help the economy.
“The market appears to be questioning the credibility of the fiscal plans, especially with another full fiscal event not due until the autumn,” they said in a note to clients.
Some analysts said Britain’s departure from the European Union had made it more exposed to swings in financial markets.
“Brexit UK is vulnerable as a less core asset in global investor portfolios,” Krishna Guha and Marco Casiraghi at Evercore ISI, a consultancy, said in a report.
Britain is due to issue nearly 300 billion pounds ($368 billion) of government bonds over the coming financial year.
OUT OF WIGGLE ROOM
In her Oct. 30 budget, Reeves gave herself only a small margin of error for meeting her target of balancing spending on public services with tax revenues by the end of the decade.
Economists think the rise in borrowing costs and economic stagnation since July’s election mean Reeves is off course to hit that target, putting her under pressure to announce new measures to show investors she can get back on track.
Reeves – who was due to travel to China on Thursday for an official visit – has said she does not plan a repeat of big tax increases after her hike in social security contributions for employers from April prompted protests from corporate leaders and caused a slowdown in their hiring plans.
Instead, she could announce spending cuts for future years, but anything that smacked of a return to what she derided as austerity under the previous Conservative governments would be another blow to the government’s already dwindling popularity.
Reeves will deliver a budget update to parliament on March 26 when the official fiscal forecasters will say whether she is on course to meet her targets.
She has previously said she favours only one major set of tax and spending announcements a year, reducing the likelihood of major measures being announced in March.
The Treasury said on Wednesday that Reeves would deliver a speech in the coming weeks on economic strategy and growth.
Mohamed El-Erian, a former chief executive with PIMCO, said Starmer and Reeves got bogged down too quickly in unpopular measures such as cuts to winter fuel welfare for pensioners.
“This is an opportunity for the government to regain control of the narrative,” he told BBC radio. “But it has to do so in a manner that’s credible which means measures, especially on the productivity and growth side.”
($1 = 0.8144 pounds)
