UK’s borrowing costs rise as Reeves’s budget prompts fears of slower interest rate cuts

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UK government borrowing costs have risen to their highest level this year as City investors bet Rachel Reeves’s budget would lead the Bank of England to adopt a more cautious approach to cutting interest rates.

The yield – in effect the interest rate – on benchmark 10-year UK government bonds rose by more than 0.15 percentage points to trade above 4.5% on Thursday, before falling back slightly, as financial markets reacted to Labour’s first budget in 14 years.

The pound also fell against the US dollar, while the FTSE 100 index lost ground amid a broader global sell-off, reflecting wider jitters over the prospect of the world’s most powerful central banks keeping interest rates higher for longer.

“The quiet optimism that appeared to be spreading during Rachel Reeves’s speech has evaporated and a higher risk premium has returned for UK debt,” said Susannah Streeter, head of money and markets at the investment service Hargreaves Lansdown.

“Bond yields are set to stay volatile, as institutions financing government borrowing keep a more suspicious eye trained on what the swollen investment budget will be spent on.”

In a historic budget to begin the task of repairing battered public services and rebooting economic growth, the chancellor announced a £70bn increase in spending on services and infrastructure, with more than half funded by higher taxes.

City analysts said Reeves had announced a more expansionary package than anticipated, including higher near-term borrowing, before hitting her newly revised fiscal rules within five years.

This would lead the government to sell more bonds, known as gilts, to cover its financing needs, analysts said. The chancellor’s plans would also boost economic growth and inflation, with potential to complicate the path for the Bank of England to cut interest rates.

“The sell-off across the gilt curve is likely partly reflective of higher than expected issuance projections after the current fiscal year,” said Shreyas Gopal, an analyst at Deutsche Bank.

“The stakes are now also higher for next week’s Bank of England meeting.”

Before the budget, financial markets widely expected the central bank to cut interest rates from their current 5% to about 3.75% by the end of next year, with a first quarter-point reduction on Thursday next week.

However, the Office for Budget Responsibility, the independent Treasury watchdog, said it had raised its prediction for the base rate by 0.25 percentage points across its five-year forecast to reflect the additional stimulus Reeves’s budget would have on the economy.

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Financial markets moved after the budget to price in fewer reductions in the base rate, predicting it would reach about 4% by the end of next year.

Analysts said that while rising gilt yields reflected concerns in financial markets over Reeves’s budget, the movements still stopped considerably short of the fallout triggered by Liz Truss’s mini-budget.

David Page and Gabriella Dickens of Axa Investment Managers said: “In terms of the overall market assessment this should in no way be compared to the disastrous mini-budget delivered under Liz Truss’s short reign in 2022.

“On that day, gilt yields jumped 33 basis points and went on to rise by 100 basis points over the next three sessions.”

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