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Gilt investors have told the UK Labor government it may need to raise taxes further to maintain confidence in the bond market after borrowing costs have risen to record highs since the financial crisis.
Chancellor Rachel Reeves has promised not to repeat the £40bn October Budget tax hike, which many businesses say will act as a drag on economic activity. But many participants in the bond market have warned that the UK government may need to look at taxes to support its finances after losing its room to move under its own financial rules.
Mahmood Pradhan, head of global macro at the Amundi Investment Institute, said the UK government “shouldn't be pulling its punches with tax cuts” and “pledges to curb spending alone may not be enough to convince markets”.
A punishing few months in global bond markets, partly driven by expectations of US president Donald Trump's inflationary policies, sent the UK's 10-year bond yield to 16 years and cleared the government chamber of defying its fiscal rules. .
Tuesday, Reeves he told parliament He is “absolutely committed” to sticking to his fiscal policies as he deflected questions from MPs about whether he would be forced to cut public spending.
The new tax hike could be politically dangerous and undermine Reeves' political standing.
The UK's 10-year bond yield rose from 3.75 per cent in mid-September to a 16-year high of 4.93 per cent last week, as global bond yields combined with investor concerns that the UK economy could in a time of inflation. – where ongoing price pressures are forcing the Bank of England to cut rates to support the flagging economy.
Wednesday's 10-year bond yielded 4.82 percent in early morning trading after inflation data opened the door to a quick BoE rate cut. Yields move against prices.
Ranjiv Mann, senior portfolio manager at Allianz Global Investors, said any rise in yields “will increase pressure on the government to take steps to address the budget deficit in March rather than waiting for the Budget in the autumn”.
The government can take “remedial measures”, Mann said, such as real spending on so-called vulnerable departments such as local government, or increasing the threshold for personal income tax beyond 2028.
Robert Tipp, head of global bonds at asset manager PGIM, said he thought the UK government could be forced by market movements to “give way” in its tax haven, rather than relying on spending restrictions. “It's a great example of where optimism can be a bad idea,” he added.
Peder Beck-Friis, chief economist at Pimco, said it is increasingly clear that the UK government needs to fix its financial situation.
“We would be very surprised if the government did not adjust the tax or the way money is used to meet these financial laws. . . we expect the government to maintain fiscal integrity and adjust these variables. “
Now there is a risk, investors have warned, that if the government does not come forward with additional monetary tightening, gilts are sold more as investors build more than “financial risk premium” in the case.
Reeves stressed on Tuesday that global factors were driving bond markets around the world and reiterated his pledge to hold one Budget a year.
The government's Office for Budget Responsibility is expected to provide updated economic and financial forecasts on March 26.
Recent gains in bond yields, if sustained, could be enough to erase the 9.9bn fiscal headroom Reeves left in the October Budget. Some economists also expect the OBR to lower its 2025 growth forecast from the current 2 per cent released in October.
The reduction in long-term growth forecasts will further affect the chancellor's budget, adding to his financial challenges.
Robert Dishner, senior portfolio manager at Neuberger Berman, said the government could consider policies such as increasing the cost of national insurance for employers, reducing the impact of inflation, and consider establishing an external review of the effectiveness of government spending.
Are there additional costs? The government may find savings here or there. “
A Treasury spokesman said: “This government's commitment to financial regulations and sound public finances is unquestionable. The chancellor has already indicated that tough decisions on spending will be taken, with a review of waste disposal spending underway. “
Additional reporting by George Parker