UK Budget outlook gets support from calmer bond markets

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UK Budget outlook and bonds

Highlights

UK Budget faces scrutiny as shrinking fiscal buffer drops from £24bn to £15bn, increasing risks of higher gilt yields if borrowing surprises emerge.
Investors are shifting to UK gilts, aided by French 10-year bond yields rising above 5 per cent and sterling's recent outperformance against the euro.
Global risk-off moves, including renewed stress in AI-linked assets, are driving flows into government bonds and helping lower UK borrowing costs.

Budget timing and bond market constraints

As reported by the Financial Times, investors are treating Wednesday's Budget as a potentially important test for the UK bond market even as major banks describe the event as likely to be subdued. The central issue is whether Healey, operating under tight fiscal constraints, avoids any surprise borrowing or spending measures that could drive gilt yields higher.

The UK remains sensitive to bond market pressure four years after the Liz Truss mini-Budget crisis, and the government is still devoting around a tenth of public spending to debt servicing. Higher global inflation and borrowing costs, partly linked to the war in Iran, leave the chancellor with little scope to fund policy through significantly cheaper borrowing.

This year's global sell-off in government bonds has also narrowed the government's fiscal buffer. Analysts cited in the article suggest that cushion has fallen from about £24bn to closer to £15bn, increasing the risks around any policy misstep or political shock, including the prospect of an early general election.

Domestic and international factors aiding the UK

At home, memories of the 2022 market turmoil are still shaping policymaking and investor expectations. The Debt Management Office and the Bank of England have recently underlined their ability to work together to limit disruption in the gilt market, while issuance policy remains highly predictable, a point highlighted by ING's David Carmalt.

The UK is also benefiting from comparisons with other major European markets, especially France. French 10-year bond yields moved above 5 per cent this week for the first time since 2002, and bankers say some investors are turning to gilts as a relatively more stable alternative, a shift that also aligns with sterling's recent gains against the euro.

Broader market moves are adding to that support. Renewed stress in AI-related debt and equities is pushing investors back toward government bonds as a defensive trade, helping pull benchmark 10-year U.S. Treasury yields down to 5 per cent for the first time in a month and easing borrowing costs elsewhere, including in the UK.

Our earlier coverage of Chancellor John Healey’s pre-Budget stance explained his commitment to sticking with deficit-reduction plans ahead of the October fiscal statement, positioning fiscal discipline as key to maintaining investor confidence. We also noted the UK’s modest 0.1% GDP growth in August and the rising political pressure around potential tax and reform choices as the Budget approached.

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