Gilt investors warn Rachel Reeves she may need to raise taxes

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Gilt investors have told the UK Labor government they may need to raise taxes more if they are to maintain confidence in the bond market after their borrowing costs have soared since the financial crisis. appeared.

Chancellor Rachel Reeves has promised not to repeat the Budget’s £40bn tax hike in October, which many businesses say works as an economic stimulus. But several bond market participants have warned that the UK government may need to look to taxes to shore up its finances after losing its operating space under self-imposed financial rules.

Mahmood Pradhan, head of global macro at the Amundi Investment Institute, said the UK government “should not be holding back on tax increases” and that “austerity obligations may not be is enough to convince the market”.

A bumpy few months in global bond markets, partly driven by the prospect of President-elect Donald Trump’s inflationary policies, have sent the UK’s 10-year bond yield to the highest in 16 years and ended the government’s struggle against its financial rules. .

On Tuesday, Reeves he told Parliament he was “absolutely committed” to sticking to his budget rules as he answered questions from MPs about whether he would be forced to cut public spending.

A new tax increase could be politically toxic and damage Reeves’ political standing.

UK 10-year yields rose from 3.75 per cent in mid-September to a 16-year high of 4.93 per cent last week, as global bond sales met with investor concerns that the UK economy is entering a period of stagflation – where persistent price pressures prevent the Bank of England from cutting rates to support a stable economy.

Ranjiv Mann, senior portfolio manager at Allianz Global Investors, said any further rise in yields would “increase pressure on the government to take measures to address the budget deficit in March rather than waiting for the Budget in the fall”.

The government can take “corrective actions”, Mann said, such as spending real money in sectors that are said to be unprotected such as local government, or increasing the rate of income tax beyond 2028.

Robert Tipp, head of global bonds at asset manager PGIM, said he thought the UK government could be forced by market movements to “justify” its tax position, rather than relying on cuts the use of money. He added: “It’s a classic example of where optimism can be a bad strategy.”

Peder Beck-Friis, chief economist at Pimco, said there is still a high probability that the UK government will need to deal with its worsening financial situation.

“We would be very surprised if the government did not change taxes or spending to meet these financial rules. . . we expect the government to maintain fiscal confidence and to correct these conditions.”

There is now a risk, investors have warned, that if the government does not come forward with further monetary tightening, gilts will sell off even more as investors build up more “financial risk premium” in debt.

Reeves stressed on Tuesday that global factors are driving bond markets around the world and reiterated his commitment to holding just one Budget a year.

The government’s Office of Budget Accountability is due to issue updated economic and fiscal forecasts on March 26.

The latest round of bond yields, if backed, could be enough to more than wipe out the £9.9bn of capital Reeves left out of his October Budget. Some economists also expect the OBR to lower its growth forecast for 2025 from the current forecast of two per cent given in October.

A reduction in long-term growth forecasts will affect the chancellor’s fiscal policy, adding to his financial woes.

Robert Dishner, senior portfolio manager at Neuberger Berman, said the government could consider policies to change policies such as the rise in the cost of employers’ national insurance, to reduce its impact on inflation, even and consider providing an external audit of government spending.

“Are there excessive costs? The government could probably find some savings here or there. ”

A spokesman for the Department of Finance said: “This government’s commitment to sound financial and public finance laws is non-negotiable. The chancellor has already indicated that tough decisions on spending will be taken, as the spending review continues to weed out the waste. ”

Additional reporting by George Parker