British bond investors reacted positively on Wednesday to lower-than-expected government borrowing plans but cautioned that tax hikes might be inevitable if economic growth remains weak.
Finance Minister Rachel Reeves adjusted government spending plans to meet fiscal targets, restoring a £9.9 billion ($12.77 billion) buffer that had been eroded by sluggish growth and rising borrowing costs. The UK Debt Management Office (DMO) announced plans to sell £299 billion in gilts for the upcoming fiscal year—below the £304 billion projected by banks polled by Reuters.
The news, coupled with lower-than-expected inflation data earlier in the day, reinforced market expectations of Bank of England interest rate cuts. Following the announcement, Britain’s 30-year bond yield dropped by as much as seven basis points (bps) before settling at around 5.32%, while 10-year gilt yields dipped by six bps before stabilizing at 4.735%.
The gilt market has been volatile since Reeves’ tax-and-spend budget in October, with benchmark borrowing costs reaching their highest levels since 2008 earlier this year. Investors had feared a larger borrowing requirement, but the announcement provided some relief. “Coming just below £300 billion certainly gives comfort to the market,” said Ranjiv Mann, a portfolio manager at Allianz Global Investors, who continues to favor gilts in his portfolios.
Adding to investor optimism, the DMO announced that only 13% of gilt issuance would be long-dated, the lowest proportion in its 27-year history. This was a welcome move for that segment of the market, which has been under strain due to high government funding needs.
Despite the positive reaction, concerns remain about the UK’s economic outlook. The Office for Budget Responsibility (OBR) halved its growth forecast for 2024 to 1% and warned that U.S. President Donald Trump’s potential tariff hikes could reduce the UK’s GDP by up to 1%.
Some investors fear Reeves will need to reintroduce fiscal measures in the autumn budget, potentially including tax increases. “There is a risk that she will have to reinstate part of the headroom,” said Aviva Investors senior economist Vasileios Gkionakis, noting that spending cuts could make tax hikes more likely.
While the OBR slightly raised its longer-term growth forecast, market skepticism remains. “Falling longer-dated yields suggest investors aren’t fully convinced,” said Invesco’s global market strategist Arnab Das. The OBR also estimated that UK borrowing will be nearly £50 billion higher by the decade’s end than previously expected.
Liam O’Donnell, a fund manager at Artemis, acknowledged the market’s short-term relief but remained cautious about the broader fiscal picture. “The immediate threat of increased gilt issuance didn’t materialize today, but the UK’s financing needs remain on an upward trajectory,” he said.
As the government navigates fiscal challenges, investors are closely watching how Reeves balances spending, borrowing, and potential tax measures in the months ahead.
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