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Bond investors have told the UK Labor government that they may need to raise taxes further if they want to retain credibility in the bond market after borrowing costs rose to their highest levels since the financial crisis.
Chancellor Rachel Reeves has promised not to repeat October's £40bn budget tax rises, which many businesses say have been a drag on economic activity. But many bond market participants have warned that the UK government may need to consider taxation to bolster its finances after losing room to maneuver under its self-imposed fiscal rules.
Mahmud Pradhan, head of global macroeconomics at the Amundi Investment Institute, said the UK government “should not box itself in by ruling out tax rises” and that “pledges to restrain spending alone may not be enough to convince markets.”
A tough few months for global bond markets, driven in part by expectations of US President-elect Donald Trump's inflationary policies, have sent UK 10-year bond yields to their highest level in 16 years and eliminated room for the government to wedge against its fiscal rules. .
On Tuesday, Reeves He told Parliament She was “absolutely committed” to sticking to her fiscal rules, ignoring questions from MPs about whether she would have to cut public spending.
New tax increases would be politically toxic and further undermine Reeves' political position.
British 10-year bond yields rose from 3.75 percent in mid-September to a 16-year high of 4.93 percent last week, as the global bond sell-off mixed with investor fears that the UK economy was entering a period of recession. Stagflation – where persistent price pressures prevent the Bank of England from cutting interest rates to support a deteriorating economy.
Any further increase in yields “will increase pressure on the government to take steps to address the budget deficit in March rather than waiting for the budget in the fall,” said Ranjeev Mann, senior portfolio manager at Allianz Global Investors.
Mann said the government could take “corrective measures”, such as cutting spending in real terms in so-called unprotected departments such as local government, or extending the freeze on personal income tax thresholds beyond 2028.
Robert Tipp, head of global bonds at asset manager PGIM, said he believes the UK government may be forced by market movements to “make room” for its tax position, rather than rely on spending restrictions. “It's a classic example of hope being a bad strategy,” he added.
Peder Beck-Fries, an economist at bond giant Pimco, said it was increasingly likely that the UK government would need to address its deteriorating financial position.
“We would be very surprised if the government does not adjust taxes or spending to meet these fiscal rules… We expect the government to maintain fiscal credibility and adjust these variables.”
Investors have warned that there is now a risk that if the government does not come forward with further fiscal tightening, the sell-off in government bonds will increase as investors build more government bonds.Financial risk premium“In debt.
Reeves stressed on Tuesday that global factors are driving bond markets around the world, and reiterated her pledge to maintain only one balance sheet per year.
The government's Office for Budget Responsibility is due to provide updated economic and fiscal forecasts on March 26.
The recent gains in bond yields, if they persist, will be enough to erase the £9.9bn windfall Reeves left herself in her October budget. Some economists also expect the Office for Budget Responsibility to lower its growth forecast for 2025 from the current 2 per cent forecast issued in October.
A reduction in long-term growth forecasts would further impact the Chancellor's budget, adding to the financial challenges she faces.
Robert Deschner, senior portfolio manager at Neuberger Berman, said the government could consider adjusting policies such as rising national insurance costs for employers, to reduce their inflationary impact, and even consider commissioning an external review of the efficiency of government spending.
“Are there excess costs? Maybe the government can find some savings here or there.”
A Treasury spokesperson said: “This government’s commitment to sound fiscal and public finance is non-negotiable. The Chancellor has already shown that tough decisions will be made on spending, with the spending review continuing to eliminate waste.
Additional reporting by George Parker
