UK bonds, pound whipsaw as investors unconvinced by budget plans

UK bonds and the pound swung between gains and losses on Wednesday as investors questioned the credibility of the government’s fiscal tightening plans.

While the yield on 10-year gilts initially fell and the pound rallied as traders circulated an Office for Budget Responsibility document released early, the market moves then reversed. That came as investors parsed the details, saying it pushed efforts to tighten the country’s finances toward the end of the decade.

The fiscal watchdog’s report showed the UK increased a buffer it keeps to avoid breaking a key fiscal rule to a larger-than-expected £22 billion ($29 billion). However, it also downgraded its growth projections to reflect lower productivity assumptions, while forecasting higher inflation and stronger wage growth.

“While the announced fiscal austerity is broadly in line with expectations, the backloading could erode the credibility of the government’s commitment to repairing public finances,” said Valentin Marinov, head of Group-of-10 currency strategy at Credit Agricole SA. “Both the pound and gilts are trading close to the lows and could continue to move in tandem in the very near-term.”

The pound swung between gains and losses of 0.3% before trading slightly up at around $1.3190 as Chancellor of the Exchequer Rachel Reeves gave her budget speech. The yield on 10-year gilts also moved from as low as 4.42% to as high as 4.54%.

The early release of the OBR report was an extraordinary development, stealing Reeves’ thunder on the biggest day in the UK political calendar. The watchdog’s forecasts are typically only released after Reeves finishes her address outlining fiscal policies.

Prime Minister Keir Starmer’s government has imposed on itself two fiscal rules in a push to win over bond investors. The first and most important is what Reeves calls the “stability” rule: that day-to-day government spending should be covered by tax revenues in the 2029-2030 financial year.

The principle is that borrowing is only for investment. While she only left a £9.9 billion buffer — effectively a spare amount of cash she can draw down without breaking the rule — in March, that is now being increased to £22 billion. That’s well in excess of the median estimate of £15 billion from the banks surveyed by Bloomberg.

“It’s less credible as usual but it keeps her in line with fiscal rules for now,” said Jordan Rochester, a head of macro strategy at Mizuho in London, on the OBR report. “It’s front-loaded borrowing, backloaded cuts — when does a Chancellor ever actually stick to that?”