For the first time in 14 years under a Labour government, UK markets saw notable fluctuations following Wednesday’s budget statement. Investors initially took a risk-averse approach, selling both government bonds and the pound, as new tax measures and increased borrowing left some market players cautious. The budget outlined a £40 billion ($52 billion) tax increase, paired with a hike in spending, a combination that rattled some investors.
Concerns Over Inflation and Interest Rate Cuts
While there is widespread anticipation that the Bank of England (BoE) will trim its main interest rate by a quarter point next week to 4.75%, some analysts worry that the inflationary pressures from the budget could slow down future rate cuts. Following the budget announcement, markets now anticipate fewer interest rate cuts in 2025, reflecting concerns over the long-term inflation outlook. The Office for Budget Responsibility (OBR), an independent fiscal watchdog, noted in its assessment of the budget that the new measures may contribute minimally to growth levels in the coming years.
Stable Bond Yields and a Strengthened Pound
As of Friday, the UK’s 10-year bond yield held steady at 4.45%, following an initial rise post-budget announcement by Treasury Chief Rachel Reeves. The pound also gained 0.4%, trading at $1.2951, highlighting increased confidence in the currency despite initial market jitters.
Reeves, who introduced the budget, was mindful of past market reactions and the potential for missteps. Notably, former Prime Minister Liz Truss’ brief leadership tenure in 2022 saw a spike in borrowing costs following unfunded tax cuts. Andrew Goodwin, Chief UK Economist at Oxford Economics, pointed out that while the market’s reaction to Labour’s budget has been “unwanted” for the new administration, it remains far more muted than the response to the Conservative mini-budget of 2022.
Business Tax Hikes at the Center of Concerns
A large portion of the increased revenue in Reeves’ budget comes from businesses through a hike in the National Insurance Contributions (NIC) by 1.2 percentage points, projected to raise £25 billion. NIC is the tax that employers pay on behalf of employees, and this change applies to lower income levels than before. Some business leaders are concerned that this additional tax burden could lead employers to cut costs by lowering wages or limiting hiring to offset the increase.
Labour Government Faces Economic and Market Challenges
Labour’s recent landslide election victory on July 4 marked a turning point after years of Conservative rule, with the new government pledging to revitalize the British economy and improve public services. However, the scale of the measures announced by Reeves on Wednesday went beyond Labour’s cautious election campaign promises.
As the UK heads into 2024, all eyes remain on how the Labour government will navigate these fiscal and market pressures, balancing ambitious plans for economic recovery with careful management of inflation and interest rates.
