(Bloomberg) -- UK government bonds fell as investors braced for Chancellor Rachel Reeves to announce an aggressive borrowing plan to boost investment and fill a fiscal “black hole” she says the previous administration left her.
The yield on 10-year gilts rose as much as seven basis points to 4.27% on Thursday before paring the move. That widened the spread over equivalent German notes to 199 basis points, the highest in a year.
The moves follow a report in The Guardian newspaper saying Reeves will give herself about £50 billion ($64.9 billion) of extra borrowing headroom in next week’s budget, more than analysts were expecting. According to the newspaper, she’d adopt “public sector net financial liabilities” as the key debt metric used in the nation’s self-imposed fiscal rules.
Reeves later confirmed in an opinion piece in the Financial Times that she plans to change the fiscal rules to allow more borrowing for investment, but didn’t detail how. She said her new rules would “ensure we don’t see the falls in public sector investment that were planned under the last government.”
“The probability of the Chancellor moving to a primary fiscal rule based on public sector net financial liabilities has increased following government briefing,” said Barclays strategists led by Jack Meaning, citing the Guardian report. “However, the precise impact on gilt issuance will depend on when the money leaves the Treasury.”
Reeves is looking to fill a hole in public accounts while also sourcing funds to improve public services through a combination of spending cuts, tax rises and increased borrowing. Her first budget, to be presented on Oct. 30, is widely seen as the moment that will shape the early years of Keir Starmer’s administration.
Barclays expects the government’s net financing requirement — which largely determines the scale of its gilt sales program — to increase between £15 billion to £20 billion in the 2025-2026 fiscal year.
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The prospect of increased borrowing led money markets to pare bets on the scope for Bank of England rate cuts next year by around six basis points, compounding the underperformance in gilts. Traders still see a quarter-point reduction next month with another four such cuts to follow by the end of next year.
“If the debt is being increased to stimulate growth — this also means that BOE will need to re adjust their policy biases,” said Pooja Kumra, head of European rates strategy at Toronto Dominion Bank, pointing to fiscal policy becoming inflationary.
Longer-maturity yields, which are usually more sensitive to possible changes in debt issuance, rose less. That could be because of a trend of the country’s Debt Management Office shifting to issue less longer-term bonds, according to Megum Muhic, a strategist at RBC Europe in London.
For Matthew Amis, an investment manager at abrdn investment management, Reeves won’t announce large spending plans in the near term because the funding needs will be spread out over years. Also the fiscal rule that says day-to-day departmental budgets need to be paid from taxation will limit her ability to borrow much more in the near term.
“I’m not sure this news impacts gilt supply this fiscal year or BOE near-term economic forecasts,” said Amis. “This is a 5- to 10-year project.”
(Updates prices in second and eighth paragraphs.)
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