Borrowing costs surge and stocks tumble over Reeves debt binge fears

Investors react to warnings that debt-fuelled Budget will raise interest rates and hurt growth

UK borrowing costs have hit their highest levels in a year and stocks have tumbled amid growing concerns about Rachel Reeves’s borrowing plans.
Benchmark 10-year borrowing costs rose by more than 3pc to 4.5pc on Thursday, as investors fretted about the Chancellor’s £32bn-a-year increase in borrowing. Analysts have highlighted it will not all be used to fund investment.
The pound also fell by a third of a percent against the dollar to $1.2922 and stocks slumped. The FTSE 250 index, which is made up mainly of domestic companies, fell by 1.4pc and the more internationally focused FTSE 100 was down by 0.80pc in afternoon trade.
The sell-off for British assets and the higher government borrowing costs came as investors reacted to warnings from economists that the Chancellor’s debt-fuelled Budget will leave the country vulnerable to changes in debt costs, put up interest rates and hurt growth.
There are also concerns that Ms Reeves may need to borrow and tax more to meet the Government’s spending commitments.
Paul Johnson, director of the Institute for Fiscal Studies, said: “There is almost no wiggle room against the two new fiscal targets, even after changing the definition of debt.
“Ms Reeves has almost as little headroom against her debt target as Jeremy Hunt had against his.
“She’s meeting her borrowing target only by repeating the same silly manoeuvres as her predecessors used to make it look as if the books were balanced.”
Mr Johnson predicted that the Chancellor’s spending plans would “not survive contact with her Cabinet colleagues”.
Economists warned that Ms Reeves’s borrowing binge to fund public spending will keep interest rates higher for longer.
Two-year yields, which most closely reflect bets on Bank of England interest rates, rose by more than 4pc to 4.5pc, the highest since May.
Analysts at Goldman Sachs and JP Morgan said they now only expected one more interest rate cut this year given “much higher spending” pencilled in by Ms Reeves, which will fuel inflation.
Investors also pared back bets on rate cuts following the Budget, and now expect benchmark borrowing costs to fall to roughly 4pc by the end of 2025, compared with 3.75pc a week ago.
Allan Monks, chief UK economist at JP Morgan, said: “The Bank of England will still likely cut in November even after incorporating the fiscal changes into its forecasts. But we are now more confident it will hold in December, barring downside surprises in wages and services inflation.
“We continue to forecast rates at 3.75pc by the end of next year. That had been looking too high, but the Budget takes out a lot of the downside risk.”
He also warned that Ms Reeves’s decision to fund some of her day-to-day spending commitments by borrowing more would be inflationary and require the Bank to keep rates higher for longer.
“The impact of this might not have been so consequential for the Bank of England if a good portion of it was investment,” he said.
“However, public investment accounts for only a third of the £60bn to £70bn increase in the path for government spending over the coming years.”
While inflation is currently below the Bank’s 2pc target, the Office for Budget Responsibility (OBR) –the Government’s tax and spending watchdog – expects it to rise and does not believe it will hit target again until 2029.
Gabriella Dickens and David Page, at Axa Investment Managers, added that the huge amount of debt the UK planned to issue also posed a risk to growth.
Higher borrowing risks driving up debt costs could hobble the economy, as more of our tax revenues are used to service that debt.
Britain’s debt interest bill is forecast by the OBR to be more than £100bn a year for the next five years, hitting £122bn by the end of the decade. This is larger than the education budget.
Ms Dickens and Mr Page said: “Gilt issuance [is] extremely elevated. As a percent of GDP, gilt sales this year are estimated to total 5.6pc.
“However, allowing for the fact that the Bank of England is also running down its gilt holdings with passive maturities and active sale, the net effect is closer to 9pc of GDP – a level of supply that is comparable to 2008-2009.”