UK Budget Analysis: FX Markets and Pound Nervous Following Jump in Bond Yields

October 31, 2024 - Written by Tim Boyer

STORY LINK UK Budget Analysis: FX Markets and Pound Nervous Following Jump in Bond Yields

In the UK budget, Chancellor Reeves announced a £40bn package of tax increases.

According to the Institute of Fiscal Studies (IFS) this is the second largest fiscal tightening on record.

There will be substantial increases in spending and government borrowing will also be increased sharply.

There was an initial decline in bond yields with the 10-year yield declining to 4.22% from 4.28% before a sharp reversal to a 5-month high of 4.39% as spending plans were released.

UK gilt issuance for 2024/25 was forecast at £297bn, slightly above expectations of £294bn and the second highest figure on record.

The Pound to Dollar (GBP/USD exchange rate dipped to below 1.2950 before a recovery to around 1.3000 as the dollar lost ground in global markets.

The Pound to Euro (GBP/EUR) exchange rate retreated to 1.1965 from 1.2020 before paring losses.

A measured increase in bond yields can support the Pound, but a destabilising increase in yields would undermine sentiment as was demonstrated in 2022.

Higher yields will also put upward pressure on mortgage rates and complicate the Bank of England stance on interest rates.

Rabobank commented; “Ultimately it will be up to investors to decide whether today’s budget is likely to have success in delivering higher investment, productivity and growth to the UK economy or whether it is instead of the ‘tax, borrow and spend’ variety.”

It added; “There is clearly a lot at stake. A sharp sell-off in the gilt market in response to today’s budget would raise borrowing costs even higher and could severely impact the credibility of Chancellor Reeves and potentially PM Starmer.”

Reeves confirmed that Employer National Insurance Contributions will be increased to 15.0% from 13.8%. Thresholds will also be lowered, although there will be increased relief.

There were also increases in Capital gains Tax and Inheritance Tax.

In addition, windfall taxes on the energy sector were extended until 2020 and it was also announced that the non-domiciled tax status would be abolished.

The Chancellor confirmed that there will be change in fiscal rules to allow increased investment over the medium term.

It claimed that there would be scope for an additional £58bn in investment spending over the next five years.

The Office for Budget Responsibility (OBR) forecasts that GDP growth will be 1.1% this year and 2.0% in 2025 with growth below 2.0% in the following three years.

The Bank of England (BoE) 2% inflation target is unchanged.

Inflation is forecast to be just above the 2.0% level throughout the forecast period.

The Chancellor announced changes to the fiscal rule with the investment rule now targeting net financial debt includes assets and liabilities.

The budget deficit is forecast to be 4.5% of GDP this fiscal year, declining to 2.5% by the end of the forecast period.

The IFS stated that spending next year will be £64bn higher than planned previously with strong increases in health and education spending.

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TAGS: Pound Sterling Forecasts