UK update: Chancellor fails to deliver knockout blow to bond market

In recent weeks it has felt like it is bond traders vs. the UK chancellor. As UK bond yields have risen sharply in recent weeks, calls have grown for the Chancellor to step down, with many blaming her budget for the relentless rise in UK borrowing costs and the drop in the pound.

Rachel Reeves addressed parliament on Tuesday. She sounded self-assured and confident, not like someone whose job is one the line, and the bond market is stable in the aftermath of her speech. However, she did not deliver a knockout blow, and the bond vigilantes have not been put to bed.

Aside from defending her position as Chancellor and promising to boost economic growth, she has not produced any concrete measures on how she will stabilize the UK’s finances. In fairness, no one expected her to list spending cuts, but financial markets may not give Reeves a long reprieve.

UK bond yields may be stable on the back of her speech, but they are not in recovery mode. Added to this, the pound is once again moving lower, which could be an ominous sign that investors are getting ready to sell UK debt once more if we get some weak economic data later this week.

GBP/USD is back below $1.2150, after recovering back above $1.22 earlier. Added to this, UK bonds have also given back earlier gains, although UK bonds are still managing to outperform European bonds and US bonds so far today. The market is willing to press pause on selling UK debt for now, and the pound may also stabilize albeit at low levels. However, a nasty upside surprise in UK inflation on Wednesday or a weaker than expected GDP reading for November on Thursday, could trigger another sell off and more concrete action from the government.

The economic situation remains perilous and there are only so many times that the Chancellor can promise to boost growth. While growing the economy is vital and it takes time, it is only one part of the equation. Financial markets are still concerned about the UK’s high inactivity rate, its low levels of productivity, its welfare bill, and its high debt servicing costs. If the UK economy continues to grow at an unspectacular rate, then the extra growth will barely cover debt bills and welfare costs, which ultimately drain public sector investment into more productive areas of the economy. Reducing the debt bill means cutting government spending, which is a tough decision that the government may need to take sooner rather than later.