This week’s Spending Review is Labour’s first since it returned to power, the first multi-year review from any party since 2021, and the first to happen outside of a pandemic since 2015. The decisions made will matter, but it will take years to see whether the money allocated to energy, transport and other infrastructure projects makes the UK a more attractive place to invest.
The UK government finances its spending through a mix of taxation and borrowing, the latter conducted primarily by issuing government bonds, known as gilts. Investors, including pension funds and foreign governments, purchase these gilts in return for regular interest payments and the promise of repayment at maturity.
Yields on UK government bonds are a key indicator of market confidence in the UK economy and its fiscal management but concerns about the scale of chancellor Rachel Reeves’ borrowing plans have driven gilt yields higher this year, increasing the cost of borrowing. Foreign investors cut back on their net holdings of UK debt by more than £9bn in April alone according to the Bank of England, and the demand for long-dated gilts also appears to be waning with a recent shift towards the issuance of cheaper, shorter-term borrowing. This could be good for keeping interest payments a bit lower and temporarily helpful to a Labour government struggling to remain within a tight set of fiscal rules.
Current UK debt is around £2.7 trillion and debt-to-GDP hovers around 100%, one of the highest levels since the 1960s. If the government’s ability to borrow is constrained, investors will be watching for any hint that taxes might rise in the next budget, risking a further suppression of economic growth.
Rachel Reeves will hope that the bond market takes her spending review in its stride but as we saw in September 2022, once confidence falters, the fallout can be significant.
The value of securities and their income can fall as well as rise. Past performance should not be seen as an indication of future results. All views expressed are those of the author and should not be considered a recommendation or solicitation to buy or sell any products or securities.
