Chancellor Rachel Reeves faced a critical test with her second budget: to regain the confidence of the international investors who fund the UK government. The verdict from the bond market, for now, is a cautious welcome, a stark contrast to the revolt that followed the 2022 mini-budget.
The so-called 'bond vigilantes' – traders who protest by driving up government borrowing costs – have been placated, at least temporarily. This follows a budget that, while containing significant tax rises, was seen as a steady hand on the Treasury's tiller after a series of policy U-turns.
The Ghost of Budgets Past
The shadow of Kwasi Kwarteng's 2022 mini-budget loomed large over this fiscal event. That plan triggered a bond market rebellion, causing government borrowing costs and mortgage rates to spike sharply and costing the public purse an estimated £10 billion.
Rachel Reeves was determined to avoid a repeat. Her key aim was clearly stated: to bring down the UK's debt costs. While the scale of this tax-raising budget wasn't in her original plans, she faced intense pressure to convince the investors she needs to fund her spending that her stewardship was dependable.
The High Stakes for UK Finances
The backdrop for this budget was concerning. Long-term government borrowing costs hit their highest level since 1998 at the end of the summer, leaving the UK with the highest levels in the G7.
The consequence is a staggering debt servicing bill. The cost of servicing the national debt this financial year is estimated at around £114 billion. This represents more than 8% of the chancellor's budget, money that cannot be spent on the NHS, defence, or education.
A Cautious Market Victory
The crucial verdict came from the Office for Budget Responsibility (OBR). Its findings, accidentally released early, initially caused bond yields to fluctuate. However, the good news for the chancellor was that they later settled lower.
This positive reaction was driven by key announcements:
- The OBR declared the government will have £21.7 billion of headroom in five years, up from £9.9 billion.
- The 'Reeves freeze' – a three-year extension of the income tax threshold freeze – was well-received.
- The budget was careful to avoid inflationary consequences, unlike the £25 billion tax on employment in her first budget.
The financial markets responded positively. The pound rose by 0.3% against both the dollar and euro, while the FTSE 100 and FTSE 250 indices rallied. Bank stocks saw relief after being spared an extra tax on profits, though gaming firms suffered from planned hikes in online gambling rates.
The Road Ahead Remains Uncertain
Despite the initial calm, the outlook remains precarious. A quarter of UK government bonds are tied to the RPI measure of inflation, which currently stands at 4.3%, up from 3.6% when Labour took office.
Laith Khalaf, head of investment analysis at AJ Bell, noted: "Early signs are yields are drifting down, but only a touch. Given what’s happened at previous budgets that’s actually a pretty good result."
The consensus is that this budget has passed its first major test. However, Rachel Reeves knows that the bond market vigilantes will descend quickly if the OBR's rosier-than-expected outlook for the UK economy fails to materialise in these uncertain times. For now, the storm has been weathered, but the skies are not yet clear.
