Althea Spinozzi, head of fixed income strategy at Copenhagen-headquartered Saxo, an investment bank specialising in online trading and investment, explains why investors should remain bearish on gilts, after UK Chancellor of the Exchequer Rachel Reeves released the Autumn Budget.

Last week's Autumn Budget appeared – perhaps appropriately for Halloween – to spook financial markets, hitting UK government bonds (gilts) and sterling because investors fretted about the rise in projected borrowing and forecasts that GDP growth is set to remain slow in the next few years. 

Althea Spinozzi at Saxo said in a note last week that the Budget poses inflation risks, with higher wages and National Insurance costs increasing labour expenses, especially in hospitality: “£100 billion ($129 billion) in public investment could further drive inflation, worsen skills mismatches, and crowd out private borrowing.” 

“Gilt issuance rises to £300 billion this year, plus £94.9 billion over four years, [are] raising sustainability concerns,” she said. Spinozzi thinks that careful management is needed to avoid market disruptions and negative impacts on investor sentiment and pricing.

Despite growth initiatives, the Office for Budget Reponsibility’s (OBR), an official group of economists which scrutinises the UK government's financial policy, cut post-2026 forecasts. High borrowing and a tight fiscal space have raised concerns about economic shock resilience and borrowing costs. 

The Budget includes a series of tax hikes expected to raise taxes by £40 billion ($52 billion), notably the abolition of the resident non-domiciled status and increases in capital gains, Inheritance Tax and employers' National Insurance contributions. 

Although the market reaction was relatively muted, gilt yields rose one day after the release of the Budget, mainly because it implies an increase in government borrowing.

“Specifically, the Debt Management Office (DMO) has outlined plans for £300 billion in gilt issuance for 2024-25, an increase of £20 billion from previous estimates. This expanded borrowing requirement puts pressure on gilt prices, pushing yields higher as investors demand more return to absorb the growing supply of government debt,” Spinozzi said.

Looking ahead, she thinks there are good reasons to anticipate that gilt yields may continue to rise.

“Inflationary pressures stemming from the budget – such as higher minimum wages and increased employer National Insurance contributions – could prompt markets to expect a more cautious approach from the Bank of England concerning rate cuts. This mix of increased inflation risks and higher supply expectations is likely to exert sustained upward pressure on yields over the longer term,” Spinozzi said.

Mark Dowding, chief investment officer at RBC BlueBay Asset Management, also said in a note last week that gilts had a rollercoaster 48 hours after Reeves unveiled the measures; they have materially underperformed other government bond markets of late. However, it may now be that much of the bad news is ‘in the price’ of bonds. The firm, which said it would struggle to build much of a bullish narrative, retains a relatively downbeat assessment on the valuation of sterling.

Yields rising
Saxo's Spinozzi outlined three key reasons why gilt yields might continue to surge in the next few weeks.

1. Rising inflationary pressure: The budget introduced significant inflationary risks. For instance, large increases in the minimum wage and employer National Insurance costs are likely to raise labour costs in many sectors, particularly low-paid service industries such as hospitality. This could exacerbate wage inflation and lead to higher prices in these sectors, contributing to broader services inflation.

2. The planned $100 billion in public investment over five years, although aimed at stimulating economic growth, might increase inflation in the medium term. Additionally, skills mismatches could worsen, driving up wages in certain sectors. This increased public investment could crowd out private sector borrowing and put upward pressure on interest rates.

3. Impact on gilt issuance: The budget necessitates higher levels of gilt issuance, amounting to £300 billion for the current fiscal year and an additional £94.9 billion spread over the next four fiscal years. This significant increase adds to concerns about the sustainability of government borrowing.

The issuance strategy has shifted focus from short-term to medium- and long-term gilts, requiring careful management to prevent market disruptions. The DMO has planned to diversify issuance across various maturities and maintain a regular schedule of syndications and auctions, which could impact investor sentiment and the pricing of gilts.

Sustainable?
While the Budget aims for growth and investment, the OBR, as stated above, has cut growth forecasts from 2026 onwards. The fiscal rules, while providing a framework for stability, offer limited headroom, raising concerns about the government’s ability to respond to economic shocks without additional borrowing.

The upward revisions in future borrowing requirements suggest sustained high levels of gilt issuance, which could increase the cost of borrowing for the government and potentially affect the broader economy.

After the Budget measures were announced, 10-year gilt yields have broken through technical market resistance at 4.35 per cent, advancing to 4.43 per cent, a level last reached during the Autumn of 2023. The overall sentiment remains bearish, with yields showing potential to test the next resistance at 4.75 per cent. “If yields manage to break above this significant level – which aligns with the 2023 peak – they could extend their upward trajectory towards the 5 per cent mark, a level not seen since before the 2008 Global Financial Crisis,” Spinozzi concluded.

See more commentary about the budget here and here.