LONDON — The cost of UK government borrowing moderated on Thursday after a sharp rise triggered by Chancellor Rachel Reeves’s emotional moment in Parliament the previous day. The yield on 10-year gilts fell from 4.61% at Wednesday’s close to 4.45%, as markets responded to Prime Minister Sir Keir Starmer’s public endorsement of Reeves and reassurances over fiscal discipline.
The pound stabilized against the US dollar at $1.3646, recovering some ground lost earlier in the week but remaining below prior levels. Market watchers interpreted these movements as a signal that investors are cautiously backing the chancellor amid speculation over her job security and the government’s fiscal outlook.
Markets React to Political Uncertainty and Chancellor’s Emotional Display
The initial surge in UK bond yields followed Reeves’s tearful appearance during Prime Minister’s Questions (PMQs) on Wednesday, when she faced intense questioning over the government’s recent U-turn on welfare cuts. The reversal, which reinstated previously planned welfare payments, leaves a nearly £5 billion shortfall in the Chancellor’s financial blueprint, shaking investor confidence.
According to Will Walker Arnott, head of private clients at Charles Stanley, markets appear to be rallying behind Reeves out of concern that her potential departure would undermine fiscal discipline. “It looks to me like this is a rare example of financial markets actually enhancing the career prospects of a politician,” he told BBC’s Today programme. “I think the markets are concerned that if the chancellor goes then any fiscal discipline would follow her out the door and that would mean bigger deficits.”
Mohamed El-Erian, chief economic adviser at Allianz and president of Queens’ College, Cambridge, cautioned that despite the fall in yields, the market remains wary. “The minute you put a risk premium in the marketplace, it’s very hard to take it out,” he said. “I suspect that we will see some moderation, but we will not go back to where we were 24 hours ago.”
Implications for Government Borrowing and Mortgage Markets
The fluctuations in government bond yields have significant real-world consequences beyond financial markets. Rising gilt yields increase the cost of borrowing for the government, which in turn can affect public spending and taxation decisions.
More immediately, higher yields tend to push up swap rates, a key benchmark lenders use in setting fixed mortgage rates. This dynamic means mortgage deals could become more expensive, potentially impacting households and the broader housing market. The last time bond yields moved sharply was during the 2022 mini-budget under former Prime Minister Liz Truss, which unleashed volatility in fixed mortgage rates and financial markets.
Rachel Reeves has emphasized her commitment to maintaining fiscal discipline despite the welfare spending reversal. “We’ll be sticking to [my fiscal rules] because they’re absolutely vital for the living standards of working people and also the costs that businesses face,” she said during an interview on Thursday.
Fiscal Constraints and Political Pressures
One of Reeves’s key fiscal rules is that day-to-day government spending should be covered by revenue, primarily taxes, with borrowing reserved solely for investment purposes. The sudden creation of an almost £5 billion black hole due to scrapped welfare reforms puts her under pressure to adjust fiscal policy.
Jane Foley, head of foreign exchange strategy at Rabobank, highlighted the challenges this poses. “The gutting of the welfare bill makes the chancellor’s job more difficult because the savings that she had planned for will not be forthcoming,” Foley explained. “Consequently, Reeves faces a choice of raising taxes, cutting spending elsewhere, or issuing more government debt. Each option faces political opposition, which means the government is somewhat boxed in.”
Foley added that political stability plays a crucial role in market confidence. “Reeves has demonstrated an understanding about the importance of maintaining fiscal discipline and it is not clear who would replace her or if that person would have the same credibility among investors. Thus, Starmer’s display of confidence in Reeves has provided reassurance.”
Prime Minister’s Support and Future Outlook
Prime Minister Sir Keir Starmer made clear his support for the Chancellor in the wake of Wednesday’s parliamentary session. Speaking to BBC Radio 4’s Political Thinking with Nick Robinson, he said he worked “in lockstep” with Reeves and praised her efforts, describing her as “doing an excellent job as chancellor.” Starmer’s comments appear to have helped calm jitters in financial markets, at least temporarily.
Reeves herself acknowledged the intense pressure she has been under but declined to discuss the personal issue she cited as the reason for her emotional moment at PMQs. She conceded that the welfare spending reversal carries a cost that will be reflected in the upcoming Budget, signalling difficult fiscal decisions ahead.
Historical Context: Lessons from Recent UK Fiscal Crises
The UK’s government bond market has shown sensitivity in recent years to fiscal policy and political developments. The 2022 mini-budget announced by then-Chancellor Kwasi Kwarteng and Prime Minister Liz Truss, which proposed unfunded tax cuts, triggered a rapid rise in gilt yields, forced intervention by the Bank of England, and a sharp depreciation of the pound. The episode underscored investors’ intolerance for perceived fiscal indiscipline.
Since then, successive governments have sought to reassure markets of a commitment to fiscal rules and debt management. Reeves’s insistence on maintaining those principles is in line with the broader objective of restoring financial stability and confidence.
Broader Economic Impact and Investor Sentiment
The bond market’s reaction to political developments is a barometer of investor confidence in government fiscal management. Rising yields can amplify the cost of financing public services and investment projects, further complicating the post-pandemic recovery and inflation management.
Financial experts warn that political uncertainty and reversal of planned spending cuts could lead to higher borrowing costs and sustained market volatility. This environment puts pressure on the government to articulate a credible long-term fiscal path, balancing economic growth, social welfare, and stability.
Fazit
While Thursday’s modest fall in UK government bond yields and stabilization of the pound offered some relief, analysts stress that market confidence remains fragile amid the complex interplay of political events and fiscal policy pressures. The Chancellor’s future and the government’s ability to uphold its financial commitments will be closely watched by investors, mortgage holders, and the wider economy in the months ahead.
As the Treasury prepares for its next fiscal statement, all eyes remain on Rachel Reeves, whose political standing now appears tightly linked with the nation’s financial market stability.
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