A brief respite for the bond market: British budget causes upheaval

The British Finance Minister, Rachel Reeves, presented her first budget, which elicited mixed reactions in the bond market. The figures released after her speech led to an unexpected reaction from investors. During the presentation on Wednesday, 10-year government bonds saw an increase of 8 basis points, gaining another 3 basis points during Reeves' speech. However, the euphoria was short-lived. Half a day later, the yields on the 10-year bonds climbed by almost 20 basis points after investors scrutinized the 205-page economic and fiscal outlook from the OBR. The information they were seeking was contained in a succinct summary of 101 words that laid out the core assessments. The budget includes an annual additional expenditure of 70 billion pounds, with two-thirds allocated to current expenses and one-third to investment expenditures. These additional expenditures are likely to delay interest rate cuts by the Bank of England. The funding is achieved half through tax increases amounting to 36 billion pounds per year, raising the tax burden to a record high of 38 percent of GDP. The remaining 32 billion pounds will be covered by additional borrowing by the British government, temporarily boosting GDP growth to 2 percent by 2026, but having little long-term impact on output. The growth surplus could gain greater significance than the unpleasant surprise in funding. Reeves' shift to new fiscal rules aimed at increasing public investment utilizes the available budget to support ongoing additional expenditures. With slightly increased economic growth, it becomes clear to market participants that the British central bank could continue to lower interest rates, but at a slower pace than previously assumed. Should the government be disappointed? Higher interest rates mean more spending on interest payments to the Bank of England and increased emissions costs for new debt. On the other hand, economic growth is seen as positive, but fiscal leeway has been nearly exhausted. In the long term, Reeves faces the challenge of rekindling interest from pension funds in new bonds, as their demand has decreased due to higher bond yields. Despite all these changes, a disaster à la the Truss mini-budget is not in sight. The expansion of collateral buffers also alleviates the burden on heavily indebted pension funds. Nevertheless, Reeves' budget could redefine short-term expectations in the bond market.