U.K. Chancellor Rachel Reeves is running into the same problem as former Prime Minister Liz Truss: the markets don’t like her plans to break Britain’s chronic economic issues.
The pound has tumbled 1.5 percent against the dollar over the past two days and hit a new 14-month low of $1.2239 in early trading on Thursday. It also hit a two-month low against the euro, as investors take fright at the prospect of ‘stagflation’ — a combination of economic stagnation and stubborn inflation.
Most worryingly for the government, its 10-year borrowing costs hit a new 17-year high on Thursday, almost reaching 5 percent before easing a little. They’re now well above the levels seen two years ago when Liz Truss’s budget sent shockwaves through local markets, pushing some pension funds to the verge of bankruptcy.
Higher bond yields make it more expensive for the government to borrow. That spells trouble for Reeves, who left herself with little headroom in a first budget last autumn that included an extra £70 billion in spending this year.
Deutsche Bank analysts Sanjay Raja and Shreyas Gopal estimate that the increase in yields since the budget was unveiled in October will have added an extra £10 billion in spending per year. That will require cuts to spending, more borrowing, or higher taxes to cover the emerging hole in the public finances, they argued.
Much of the sell-off in recent days has been due to a rise in global bond yields. Investors have sold U.S. bonds heavily in anticipation of Donald Trump’s return to power, fearing that he will stoke inflation with his policies on tariffs and deportations.
However, two factors are making the U.K.’s problems particularly acute. Firstly, the Bank of England’s loss of credibility over a three-year bout of inflation has made investors demand a higher risk premium for holding U.K. debt. Secondly, the Bank is also selling gilts back into the market as part of its monetary policy, something known as quantitative tightening.