Bond Market Pressure Could Force Second Budget
Chancellor Rachel Reeves could be compelled to deliver a second budget if her fiscal plans disappoint financial markets next week, according to a leading City investor. David Zahn, head of European fixed income at Franklin Templeton, warned that a negative reaction from bond investors might force the government's hand.
Critical Thresholds for UK Debt
Zahn identified that yields reaching 6% on either 10-year or 30-year UK bonds would be unsustainable, creating what he described as a death spiral for government finances. Currently, 30-year bond yields stand at 5.35%, having reached a 27-year high of nearly 5.75% in early September. Ten-year yields are trading around 4.53%.
The warning comes as the Labour government prepares its first major budget on 26 November, with Franklin Templeton, which manages $1.69 trillion in assets, expressing concern about the chancellor's limited options.
Market Reaction to Fiscal Plans
Zahn suggested that markets are unlikely to respond positively without significant spending cuts or substantial tax increases. He noted that last Friday's bond sell-off occurred after reports emerged that Reeves had abandoned plans for a manifesto-busting income tax rise.
Instead, the chancellor is expected to freeze tax thresholds, which ING estimates could raise £10 billion annually as inflation pushes more workers into higher tax brackets. However, Zahn believes this approach may not satisfy markets seeking stronger action on deficit reduction.
The chancellor previously had just £10 billion of fiscal headroom, which is thought to have been eroded by expected downgrades to UK productivity growth forecasts. Zahn suggested markets would prefer to see headroom north of £20 billion.
Michael Browne of the Franklin Templeton Institute noted that the legacy of the 2022 Liz Truss mini-budget crisis continues to influence market sentiment, creating additional pressure for the current government to demonstrate fiscal responsibility.
