Introduction to the Budget
It was a budget that had to regain the trust of people lending money to national governments. This doesn’t sound like a priority, but there are thousands of traders making judgments that can make or break a chancellor. The message was clear and it cost the public purse an estimated £10 billion after the 2022 mini budget, which caused the cost of government loans and things like mortgages to rise sharply.
The Impact of the Mini Budget
The mini budget led to a bond market revolt against the then chancellor’s growth plans, resulting in a so-called bond vigilante group. Such people protest loudly when they don’t like what they hear. The overall extent of the damage is likely to have been much greater. The cost of long-term government borrowing reached its highest level since 1998 at the end of the summer, giving the UK the highest level of any G7 country.
The Current Budget
Rachel Reeves was never in danger of triggering such a bond market backlash in this budget. After all, we knew all the key details of the policy in advance and it had clearly stated that its main aim was to reduce the UK’s debt costs. But because the size of this tax increase budget was not included in its original plans, it has been under intense pressure to convince the investors it has previously had to use to fund its spending plans that it is trustworthy in leading the Treasury.
Market Reaction
The cost of servicing our national debt in the current financial year is now estimated at around £114 billion – that’s more than 8% of the Chancellor’s money that cannot be used for the NHS, defense or education. The bond market would have been happy about the “Reeves freeze” – the three-year extension of the Tory freeze on income tax thresholds. The Office for Budget Responsibility’s judgment that really counts caused bond yields to fluctuate, but they leveled off later.
Economic Outlook
The pound rose 0.3% against the dollar and euro to above $1.32 and €1.14. The British stock market also recovered, with both the FTSE 100 and FTSE 250 ending the day higher. There was relief for bank stocks after the industry was spared an additional profit tax. Gambling companies suffered from the planned increases in online gambling prices. Assuming there is no further reversal, the outlook for UK borrowing costs will now depend on how quickly inflation can fall.
Inflation and Interest Rates
A quarter of British government bonds are linked to the RPI inflation measure, which is currently at 4.3%. When Labor came into office, it was at 3.6%. This should help push through a rate cut from the Bank of England before Christmas. The bond market’s reaction to the budget has been cautious, with yields falling slightly. This is actually a pretty good outcome, considering what has happened in previous budgets.
Conclusion
The budget has passed its first major test, but Rachel Reeves knows all too well that if the OBR’s rosier outlook for the UK economy does not materialize in these uncertain times, bond market vigilance will quickly wane. The budget’s success will depend on how well it can navigate the challenges of inflation, interest rates, and market expectations. Only time will tell if the budget will be able to achieve its goals and regain the trust of investors.
