Budget: Market worries about borrowing emerge

The yield on UK government bonds (gilts) rose in the weeks ahead of Labour’s first Budget in 15 years, partly driven by concerns about the potential for high levels of additional gilt issuance and an easing of the government’s fiscal stance, which creates more liquidity in the financial system.

A lot of this was attributed to uncertainty in the US, with UK gilts and US Treasury bonds continuing to move in lockstep. Gilts are very heavily influenced by global government bond moves, and therefore economic data from the US and Europe, but as investors digested the raft of changes introduced by the Chancellor, the cost of UK government borrowing has risen Big tax rises are coming, but not as quickly as big spending increases.

On the day the Budget was delivered, there was a sharp sell-off in the hours following the statement as markets digested the extent of fiscal easing announced by the Chancellor. The Office for Budget Responsibility (OBR) revised the bank and gilt rate upwards by 25bp over the forecast period, reflecting expectations of higher rates for longer. Furthermore, the anticipated additional £20bn of gilts issuance was skewed more to the long end of the yield curve than markets were anticipating, promoting a greater rise in longer-dated yields, and a steepening of the yield curve.

Now that the full details are available, borrowing is projected to rise significantly over the next few years. The Independent Office for Budget Responsibility calculated that borrowing will, on average, be £36bn – or 1.3% of gross domestic product (GDP) - higher each year over the next five fiscal years. This will result in a sizeable increase in bond issuance.

Tax rises are coming through gradually and credit ratings agency Moody’s warned on Friday that the UK’s fiscal rules posed an “additional challenge” to repairing the public finances. It noted that the higher borrowing announced in the Budget will allow only a limited buffer to absorb and shocks and stay compliant with the new fiscal rules. Peer S&P Global said that it was unclear whether the government would be able to stick to them. The concerns also prompted a slide in sterling.

AIM shares relief rally

Shares in the Alternative Investment Market (AIM) rallied on relief that the inheritance tax break for shares quoted on the market was not completely abolished, as some had feared ahead of Ms Reeve’s statement. Rumours had swept the City that the allowance, which allows these shares to be inherited without being taxed if held for more than two years, would be scrapped in a move that could raise around £1.4bn.

Instead, it has been changed so only a 50% relief from inheritance tax will be applied, setting the effective tax rate at 20%. This was part of a host of inheritance tax measures that were unveiled, which are meant to raise as much as £2bn. Fully scrapping this allowance would have likely resulted in a significant plunge in the junior market.