Bond markets may force Rachel Reeves to deliver a second budget if investors react negatively to next week’s fiscal plans, a senior City investor has warned, underscoring the fragile backdrop the chancellor faces ahead of 26 November.
David Zahn, head of European fixed income at the $1.69 trillion asset manager Franklin Templeton, said the biggest risk to Reeves was that markets “disappoint” rather than celebrate the Budget — a scenario that could push up gilt yields sharply.
“If the bond market reacts very badly, the government will have to react if bond yields start to go up too much,” Zahn said. “It could force her hand to do a secondary budget.” He added that yields on 10-year or 30-year UK government bonds reaching 6% would be “unsustainable”, warning of a potential “death spiral” if borrowing costs rose too far.
UK 30-year gilt yields currently stand at 5.35%, down from a 27-year high of almost 5.75% in early September. Ten-year yields are trading at 4.53%.
Zahn said bond investors are unlikely to welcome the Budget because the Labour government appears unable or unwilling to push through spending cuts. That reduces the scope to bring borrowing down and limits the chance that gilt yields will fall.
“If she’s not going to tackle any of the big taxes, I don’t see what she can do that the market will go ‘fantastic, you fixed it’,” he said. “She’s not doing any spending cuts.”
The warning follows reports that Reeves has abandoned a plan to raise income tax — a move Zahn argued “markets would have taken very well” as a sign of serious fiscal tightening. Instead, Reeves is expected to freeze tax thresholds, which ING estimates will raise £10 billion a year as more workers are pulled into higher tax bands through fiscal drag.
The chancellor may also raise a range of smaller taxes to generate extra revenue.
Markets will be watching closely to see whether Reeves creates enough fiscal space to meet Labour’s rule of having debt falling in five years. She had previously left herself only £10 billion of headroom — a buffer now thought to have been eroded by a downgrade in the UK’s long-term productivity outlook.
Zahn suggested the markets would prefer to see at least £20 billion of headroom in the Budget. He also predicted further tax rises were likely next year: “I don’t think this is a one-off. She probably won’t be back next year, but somebody will be.”
Analysts at ING warned that any spike in borrowing costs after the Budget could be driven by politics, not economics.
James Smith, ING’s developed markets economist, said falling Labour poll ratings and pressure on Keir Starmer could fuel market speculation about leadership instability: “If a challenge looked imminent, markets might assume a new PM would appoint a new, potentially more left-leaning chancellor — one more likely to change fiscal rules and increase borrowing.”
Michael Browne, global investment strategist at the Franklin Templeton Institute, said the shock of the 2022 Liz Truss mini-budget crisis is still shaping investor behaviour.
“The markets aren’t forgetting that either,” he said. “Get it right, and the UK is exciting from a bond and equity point of view. But at this point, what’s the evidence we’ll do anything other than muddle through? And muddling through comes with risks.”
