Rachel Reeves is facing her first major test as Britain's finance minister after the government's borrowing costs jumped sharply this week and the pound tumbled, potentially forcing her to cut future spending.
The Treasury said late on Wednesday that it would maintain "an iron grip" on the public finances in response to a two-day selloff in debt markets that pushed the yield on 30-year British government bonds to a 26-year high.
The value of the pound fell along with gilt prices, prompting some comparisons with the 2022 "mini-budget" crisis that forced former prime minister Liz Truss out of Downing Street although this week's market moves have been less sharp.
Gilt yields rose again in early trade on Thursday while the pound was headed for its biggest three-day drop in nearly two years.
Investors, already on edge about the incoming administration of U.S. President-elect Donald Trump, are worried about the combination of high borrowing in Britain planned by Reeves and Prime Minister Keir Starmer and the impact of their higher taxes for business.
The launch last October of the new Labour government's programme for more investment in public services and infrastructure to speed up economic growth coincided with a rise in borrowing costs in global financial markets triggered by Trump's election victory.
"The gilt selloff of the last few days has inevitably grabbed the headlines, where a common conclusion is to point fingers at the government," Mike Riddell, portfolio manager and fund management giant Fidelity International said.
"But this would miss the point. It is mainly a global fixed income story."
Benchmark U.S. 10-year yields hit their highest levels in more than eight months on Wednesday on concerns about the inflationary implications of the policies that Trump's administration could revive, chief among them his promise to impose sweeping import tariffs.
That could push up inflation in the U.S., leaving Treasury yields high with a knock-on effect on UK market rates which strain the British government's already tight budget and weigh on the economy.
Furthermore, investors think the Bank of England is likely to move only slowly with interest rate cuts, given the persistence of inflation pressures in Britain's jobs market.
OFF TRACK
Some of the problems facing Reeves stem from her first budget speech on Oct. 30 when she gave herself only a small margin of error for meeting her target of balancing spending on public services with tax revenues by the end of the decade.
Economists think the recent rise in UK borrowing costs and a stagnant economy since around the time of the election last July mean Reeves might already be off course to hit, requiring her to announce new measures to show investors she can get back on track.
Reeves has said she does not plan a repeat of big tax increases after her hike in social security contributions for employers from April prompted howls of protests from corporate leaders and caused a slowdown in their hiring plans.
A survey or recruiters on Thursday showed that vacancies slumped in December.
Instead, she could announce spending cuts for future years but anything that smacked of a return to what she derided as austerity under the previous Conservative governments would further hit the governing Labour Party's already dwindling popularity and cause strains in the cabinet.
The next official fiscal forecasts are due on March 26 when Reeves will deliver a budget update speech to parliament.
The Treasury said in its statement on Wednesday that Reeves would deliver a speech in the coming weeks on her economic strategy and plan for growth.
Mohamed El-Erian, a former chief executive of bond fund giant PIMCO, said Starmer and Reeves did well to focus initially on improving the weak productivity growth but got bogged down in unpopular measures such as cuts to winter fuel welfare for pensioners.
"The government basically lost traction on its growth mission, so this is an opportunity for the government to regain control of the narrative," he told BBC radio. "But it has to do so in a manner that's credible which means measures, especially on the productivity and growth side."
