UK government bonds, shares and sterling plunged as budget rumors circulated
British markets were shaken on Friday, with sterling, government bonds and shares suffering heavy losses on speculation surrounding the UK government’s much-anticipated Nov. 26 budget.
Finance Minister Rachel Reeves has no plans to raise income tax rates in the budget, government sources said on Friday, worrying investors who had anticipated tax increases to help fill an expected fiscal shortfall.
Markets saw a sharp sell-off after the Financial Times first reported the news, and only recovered slightly after other media outlets, including Reuters, quoted sources as saying improved fiscal forecasts were one factor in the change.
However, UK assets remained under pressure, highlighting fresh uncertainty.
The yield on the 10-year government bond, or gold, jumped 13 basis points to 4.58%, the highest in a month, and was set for its biggest one-day gain since July when concerns around Reeves’ position as finance minister roiled markets.
Gilts underperformed their US and German peers,,. Bond yields move inversely to prices.
Sterling fell 0.4% to $1.312 and fell against the euro, which hit its strongest level against the pound since April 2023 at around 88.64 pence.
“Clearly, the market is hoping the government will take steps to address the fiscal shortfall and that means an increase in income taxes,” said Jeremy Stretch, head of G10 FX Strategy at CIBC Markets.
He said media reports had shaken that view, “so, what we are seeing is a lack of confidence from the market and particularly the bond market.”
British government bonds had, until Friday, outperformed other countries, helped by traders’ bets that weak economic data and lower inflation would help the Bank of England cut interest rates more quickly, and what they thought was Reeves’ plan to raise income taxes.
Ten-year yields are still down about 20 basis points from early September, but up more than 10 bps from lows in mid-October.
“The market is quite satisfied that the bond market has won, that he (Reeves) is so afraid of disrupting the gold market and creating another ‘Liz Truss moment’ that he will raise taxes, and they like the cleanliness of the proposal,” said Jane Foley, head of FX strategy at Rabobank.
Truss, a former prime minister, left office after just seven weeks in 2022 when bond prices fell in reaction to her budget plans.
Foley said Reeves has other options such as property taxes, or pension fund changes, but “these are not as clean, and may have larger secondary implications, and could alienate the business community.”
The market is also concerned that Reeves may have to borrow more, he added.
BUDGET SHORTAGE
Reeves is expected to need to raise tens of billions of pounds to stay on track with his fiscal targets, and his recent comments that “we all have to contribute” were seen as paving the way for the government to renege on a key election promise and raise income tax rates.
British Prime Minister Keir Starmer’s authority within his ruling party is also under pressure.
Britain’s blue-chip FTSE index slumped 1.3%, with shares of Barclays, Lloyds and Natwest banks down around 3% each.
Traders said lenders were hurt by concerns that if Reeves does not raise income taxes, higher taxes on banks may be needed to fill the fiscal hole.
Usually higher bond yields will make a country’s currency higher. But on several occasions this year, concerns over Britain’s fiscal position have caused government bonds and sterling to sell off simultaneously.
This, said Foley, was partly due to the high amount of gold held by foreign investors.
Traders also assessed the impact on the Bank of England, which is widely expected to cut interest rates in December.
A less fiscally tight budget or a budget that contributes to higher inflation – something Reeves wants to avoid – could complicate the picture.
“If the market ultimately believes in the forecast for future growth, which is slightly more optimistic than the consensus, then the market should calm down,” said Seema Shah, chief global strategist, Principal Global Investors.
“But right now, I expect the stress to last longer.”
Source: Reuters (Reporting by Alun John and Dhara Ranasinghe, additional reporting by Rae Wee in Singapore and Iain Withers in London; Editing by Peter Graff and Andrew Heavens)
