UK budget: the devil in the detail

Poor reaction from gilt markets

On 30 October, nearly four months on from its landslide election victory, the UK’s Labour government delivered its first budget in nearly 15 years. For much of that intervening period of last four months, the government had been laying the groundwork for what might lie ahead; testing the resolve of financial markets by leaking potential policy announcements and analysing the reaction. With the events of September 2022 still etched in the minds of politicians and market participants alike, the stakes were high. So why, with the market so well prepared for what might come, have gilt markets reacted so poorly? Whilst the initial move higher in yields was possibly sparked by the UK Debt Management Office’s (DMO) revision to the gilt remit, it was the devil in the detail of the budget that mattered most. Namely, the Office of Budget Responsibility’s (OBR) forecasts for a) inflation and b) the sheer scale of the increase in government borrowing.

With more syndications pencilled in, perhaps the DMO is looking to take advantage of the insatiable demand for gilts via the syndication programme.

On the gilt remit, there was little surprise in the overall revision to fiscal year 2024-25 borrowing numbers; the increase of £22.9bn was broadly in line with the market forecast for £20bn. However, the market was expecting, and very well positioned for the increase in borrowing to be well split between UK T-bills and gilts, and for the gilts to be issued predominantly in shorter maturities. In the end, issuance was not only skewed significantly towards gilts but also in longer maturities as well. With more syndications pencilled in, perhaps the DMO is looking to take advantage of the insatiable demand for gilts via the syndication programme. Time will tell. But this announcement, and market positioning, certainly played their part.

Upwards pressure on inflation

The bigger concerns for the market however revolve around two consequences of announced government policy: inflation and borrowing. There is a risk that the combination of an increase in the national living wage, tax on national insurance contributions, and previously announced labour market reforms, place upward pressure on inflation. The OBR forecasts that inflation will be 2.5% next year and remain above the Bank of England’s (“BoE”) CPI target of 2% for the remainder of the forecast period. That has put pressure on the front end of bond markets, especially given that markets were expecting the BoE to be cutting rates throughout much of next year. And on borrowing, markets have taken fright at the prospect of an additional £100bn of supply over the next few years. On average, borrowing will be nearly £273bn per annum for the next few years.

Borrowing up, inflation up, and growth down, was not the outcome the markets were looking for.

Borrowing has been materially increased, without any real commitment to improve productivity and boost the supply side of the economy. Despite the boost to spending, the OBR downgraded its growth projections from where they were at the 2024 Spring Budget. And there are further question marks over just how much money might be raised through the governments tax changes. Borrowing up, inflation up, and growth down, was not the outcome the markets were looking for. In essence, the government has taken a risk with the public finances. There is little headroom in the numbers, and if growth disappoints, the Chancellor will be back at the dispatch box, raising taxes and borrowing further. Markets remain nervous, and rightly so.

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