Picture by Kirsty O'Connor / Treasury.
Markets are rapidly losing faith in Chancellor Rachel Reeve's budget measures and are dumping UK assets.
Analysis from Deutsche Bank says Reeves will now have to borrow more, cut spending and raise taxes.
"Gilt yields have continued to rise sharply to start the year. So even before the OBR can put pen to paper, Chancellor Reeves has a big problem. The razor-thin headroom left in the Autumn Budget has likely all evaporated," says Sanjay Raja, Senior Economist at Deutsche Bank.
The call comes as UK government bond yields soar and the Pound heads in the opposite direction:
- 10 year gilt yield up to 4.787% - highest since 2008.
- 30 year gilt yield up to 5.347% - highest since 1998.
- GBP/EUR down 0.60% at 1.1989.
- GBP/USD down 1.0% at 1.2348.
Typically, bond yields and the Pound hold a positive correlation, meaning that when yields rise, the Pound follows.
It is only when a crisis of confidence emerges that the correlation breaks. The market is signalling this is now happening.
"Sterling is suffering from what I refer to as a 'bad' rise in gilt yields. Typically, higher inflation expectations or a hawkish adjustment to the BoE policy stance drive yields higher, and that is bullish for the pound. In this case, the move is driven not by the macro data, but by heavy gilt supply, concerns about the UK government’s debt sustainability, and the inflationary impacts of the extra fiscal spending in the pipeline," says Kyle Chapman, an analyst at Ballinger Group.
Viraj Patel, a strategist at Vanda Research, says "One of the biggest red flags in macro markets - and a sign of fiscal un-anchoring - is yields up and currency down. This is happening again in the UK (the last proper time we saw this was Q4 '22... after 'that' Budget). Looks ominous."
Above: Ten-year bond yields (top) and GBP/USD part ways, in a sign investors are losing confidence in UK assets.
As the cost of servicing debt rises, the government is forced to look for funds to make payments to its creditors.
"How much bigger is the UK's debt burden? Based on current market expectations, we expect central government net interest costs to track around GBP 10bn more per annum between 2025/26 and 2029/30 (relative to the Autumn Budget projections)," says Raja.
"There's more to the story too. On 26 March, when the OBR presents its updated economic outlook, a raft of economic changes look inevitable," he adds.
Deutsche Bank thinks GDP growth will likely be revised lower from its optimistic 2% projection for the current calendar year.
Inflation will be revised higher, adding to debt costs, as a significant portion of UK debt is priced on the Retail Price Index, which is a measure of inflation.
The OBR's unemployment projections will also likely rise further, in line with a string of economic surveys showing businesses will shed jobs in reaction to Rachel Reeve's business tax raid.
"What does this mean for the fiscal outlook? Spending cuts, more borrowing, and likely a little more taxation to close the emerging fiscal hole," says Raja.
"Indeed, the forthcoming Spring Statement, Spending Review, and Autumn Budget will likely be painful sequels to the Chancellor's historic inaugural budget," he adds.
In this environment, is it little wonder we are seeing investors dump UK bonds and the Pound?