The UK's newly released budget has sparked broad market attention and a swift reaction, leading to a comprehensive decline in the pound, UK government bonds, and the stock market. On October 31, investors expressed concern over the UK Labour government's plans to increase borrowing and take on higher inflation risks, triggering a sell-off of UK assets. The pound fell to 1.2843 against the dollar, hitting a new low since August 19, and hovered around 1.2895 in the Asian market on November 1.
Investors anticipate that the Bank of England may cut the rate of interest reductions to address the budget announced by Chancellor Rachel Reeves, driving short-term borrowing costs to the highest level since May this year. Alongside the pound's decline, the FTSE 250 index also saw a significant pullback, marking the largest single-day drop since August and reflecting the market's repricing of UK assets.
Although this market fluctuation is not as severe as the turmoil caused by Liz Truss's unfunded tax-cutting plan two years ago, it does highlight the instability brought by the new budget. The Labour government had pledged to maintain fiscal prudence, but now the bond market is expressing dissatisfaction with its relatively loose policies, with investors particularly worried about the inflationary pressure the budget might add and its impact on future monetary policy.
In the bond market, the yield on the UK's two-year government bonds rose by 21 basis points, closing up at 4.44%. The 10-year bond yield also increased by 18 basis points, reaching 4.53%, close to the highest level in a year. The market anticipates four interest rate cuts by the end of 2025, compared to the previous expectation of five.
The sell-off also affected other asset classes, including sectors sensitive to yields such as real estate investment companies, retail, and utilities. Particularly, homebuilder stocks were hit hard, with Taylor Wimpey shares falling 6.7%, Persimmon down 7.5%, marking the largest drop since 2020, while Barratt Redrow declined by 5.1%. Among the main stock market companies' equity basket in the UK, the yield-sensitive sectors fell by 2.6%, marking the largest drop in three months.
On Wednesday, the UK's Debt Management Office announced plans to issue £297 billion (equivalent to $386 billion) in government bonds for this fiscal year, marking the second-largest issuance ever and exceeding market expectations. The extra funds will support extensive fiscal spending, with the Office for Budget Responsibility calling it the "largest fiscal loosening in decades." RBC strategist Megum Muhic noted that the bond market's reaction to the plan has been poor, with the market thinking that the spending plans may not effectively boost the UK economy, and the huge bond issuance will increase market pressure.
Global markets are also highly attentive to this situation in the UK, as other countries are undertaking similar large-scale financing plans. US investors are closely watching the upcoming presidential election results, as the new government may introduce larger spending plans, exacerbating borrowing and the fiscal deficit. Wall Street veteran Ed Yardeni warned that "turmoil in the bond market may be brewing."
Rachel Reeves stated that maintaining economic and fiscal stability is a core commitment of the Labour government, but the market's reaction to the new budget underlines this challenge.
