UK’s Reeves faces market slump challenge

Britain’s finance minister Rachel Reeves and Prime Minister Keir Starmer are seeking to stem a market slump, but for now what happens next to rising government borrowing costs and the falling pound is largely beyond their control.

Donald Trump and US economic data are likely to have a bigger influence on whether this month’s UK selloff proves to be a blip or the start of a crisis for Starmer’s government, elected last July. Reeves, visiting China at the weekend, said her targets for fixing the public finances – which have been hit by the rise in borrowing costs – were non-negotiable and “we will take actions to ensure that we meet those fiscal rules”.

Early on Monday, 30-year gilt yields hit a new post-1998 high and sterling fell to its lowest since November 2023. Asked about the market situation, Starmer told reporters his team would be “ruthless” about repairing the budget. The government has blamed previous Conservative governments for damaging the economy and public finances after the shocks of Brexit and the mini-budget crisis under former Prime Minister Liz Truss in 2022.

But Reeves has limited options to change the tone in markets. If Britain’s budget forecasters say on March 26 that Reeves is off-course to meet her fiscal rules, she could announce future spending cuts to get them back on track, according to Reuters.

She already plans a lot of spending restraint, however, and the prospect of more pain would anger many of the governing centre-left Labour Party’s members and voters.

The option of more tax hikes seems to be off the table with firms cutting hiring after Reeves hit them with higher social security contributions in her October budget.

“It’s a tough balancing act with no easy solutions,” Hetal Mehta, head of economic research at St. James’s Place, said.

Reeves is due to make an economic growth speech in the coming weeks before setting out a detailed plan in a two-year Spending Review expected in June. Measures announced so far for speeding up the economy are only expected to have a meaningful impact in the 2030s. Reeves’ next full budget is due in October or November, by which time the global economic picture could be very different.

US President-elect Trump’s promise to impose additional tariffs on imports is widely expected to push up US inflation and investors are pricing in only one interest rate cut by the US Federal Reserve in 2025.

Then there is Britain’s reliance on what former Bank of England Governor Mark Carney called “the kindness of strangers” to offset its large current account deficit, the second-biggest in the Group of Seven after the United States.

Sanjay Raja, Deutsche Bank’s chief UK economist, said many of those strangers are proving more fickle than in the past, with pension and insurance funds – which often need to hold bonds long-term for regulatory reasons – taking only 20% of sales of new government debt, down from 75% two decades ago. Foreign ownership is up, meanwhile, largely due to the rise of hedge funds. Also beyond the Reeves’ control are Bank of England interest rate decisions. Investors currently see a roughly 75% chance of two quarter-point BoE rate cuts in 2025, fewer than the almost four expected from the European Central Bank, the Reuters report adds.

A much stronger-than-expected US payrolls report on Friday – which suggested little need for the Fed to speed up its rate cuts – took a whole US cent off the value of the pound.

Ben Zaranko, a senior research economist at the Institute for Fiscal Studies think tank, said Reeves would probably avoid rushing out short-term measures to settle financial markets that could be seen as a sign of panic within the government. Mehta at St James’s Place said the big unknown for Reeves remained the outlook for the world economy.