The more investors dig into Labour’s first Budget, the less they seem to like it. After the Office for Budget Responsibility published its assessment of the Chancellor’s measures yesterday afternoon, some immediate (and expected) volatility set in. But rather than settling down, market jitters seem to have worsened today, as a gilt sell-off saw government borrowing costs hit their highest level in 2024 this afternoon, with the 10-year gilt yield reaching 4.52 per cent and the five-year gilt yield reaching 4.41 per cent.
So far the situation is manageable for the government – but is a strong indication that the markets are not quite as on-side with their plans for spending as had been suggested. It seems not even the staggering £40 billion worth of tax hikes have not balanced out the £160 billion worth of additional borrowing Rachel Reeves has planned over the course of this Parliament.
Meanwhile the pound has also taken a tumble, falling to its lowest point in two months: $1.29 against the dollar. While austerity in the form of tax hikes was certainly implemented in the Budget, it hasn’t quite worked to convince markets that the UK’s plans for borrowing are fully under control.
Part of the problem will be the massive increase in spending on services like the NHS. With more than £22 billion worth of additional day-to-day spending going to the health service (without any reform attached), already public policy circles are doubting that tax and borrowing will stick at the levels announced in yesterday’s Budget. Paul Johnson at the Institute for Fiscal Studies notes how ‘incredibly front loaded’ the borrowing and spending is; ‘day-to-day public service spending, after inflation and the additional cost to public sector employers of rising NI, is set to rise by 4.3 per cent this year and 2.6 per cent next year, but then by just 1.3 per cent each year thereafter.’ Similar to the Tories’ pledge to cut spending dramatically in the years to come, it’s hard to believe Labour really intends to reduce its spending plans so substantially, especially in the run-up to an election. This suggests yesterday’s announcements are the start of what’s to come. Far from giving markets confidence, it’s uncertainty that has come to characterise the government’s borrowing strategy.
It should be said that Reeves is still far off breaking her own borrowing rules. And unlike the aftermath of the mini-Budget, the story of borrowing costs is being told over days, not hours. But costs are still moving in a more expensive direction, which will cause the Treasury plenty of problems, even if no policy undergoes a U-turn. The OBR forecasts that both interest rates and government borrowing costs will be roughly a quarter of a percentage point higher due to Reeves’s plans – but if headline figures settle higher than expected, that will add billions of pounds on to the government’s bills.
Winning over the markets was one of the biggest challenges in Reeves’s first Budget – and borrowing more was always going to be tricky, with the era of low interest rates long gone. So far they don’t seem convinced that this is an agenda for growth, which is why investors want a bigger pay-off for the risk they’re taking. Don’t be surprised if the goalposts shift: the hope for the government now is not that markets celebrate this Budget, but that they come to tolerate it.
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