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UK chancellor Rachel Reeves’ plan to borrow more poses an “additional challenge” to repairing the public finances, rating agency Moody’s warned on Friday, as the gilt market steadied after two days of turmoil.
In an assessment of the Labour government’s inaugural Budget, Moody’s said Reeves had left herself only a limited buffer to absorb unexpected shocks and still remain compliant with her new fiscal rules.
The higher borrowing in the Budget could push up the cost of issuing debt, it added in a note to investors.
The verdict from Moody’s came as relative calm returned to gilts, following a sell-off prompted by the scale of debt issuance that pushed long-term borrowing costs to their highest level of the year.
The 10-year yield edged down 0.01 percentage points on Friday to 4.44 per cent, below Thursday’s high for the year of 4.53 per cent. Yields have climbed from 4.21 per cent during Reeves’ Budget speech on Wednesday as investors worry about the volume of gilt issuance planned.
Rival ratings firm S&P Global said the changes to fiscal rules sent a “mixed message” and that it was unclear whether the government could stick to them. “The rules themselves could be subject to further changes,” S&P said, adding that the Budget had not changed its view that strengthening the public finances would be a “challenging task”.
Reeves on Wednesday unveiled a Budget that raised taxes by more than £40bn while boosting borrowing as she funds an increase in day-to-day spending and government investment.
“In our view the increase in borrowing, which is in part supported by a new measure of debt under the fiscal framework, will pose an additional challenge for what are already difficult fiscal consolidation prospects,” Moody’s said.
Responding to the post-Budget gilt sell-off, Reeves said on Thursday that the government’s “number one commitment” was to economic and fiscal stability, insisting in a Bloomberg TV interview that she had put in place robust fiscal rules and that there would be a “significant fiscal consolidation”.
Moody’s also warned that the Budget would do little to improve UK economic growth in coming years.
“We expect growth in our baseline to remain muted and average 1.7 per cent between 2025-27 until structural constraints, including labour market inactivity that has worsened since the pandemic and persistent lacklustre productivity growth, are durably addressed,” it said.
Moody’s said higher levels of borrowing “can push up the cost of new debt issuances”, adding that debt markets were already sensitive to UK policy “mis-steps” following the gilt market turmoil after then-chancellor Kwasi Kwarteng’s so-called “mini” Budget.
Frequent changes to the UK’s fiscal rules had “weakened their effectiveness as a credible policy anchor”, Moody’s said, noting that “the UK’s fiscal policy effectiveness has been eroded in recent years, and particularly since the Brexit vote in 2016”.
The agency added that Reeves’ decision to shift to a stricter three-year rolling timeline for meeting her revised rules demonstrated a commitment to sticking with the new regime and would support its credibility.
In a statement on Friday, Reeves said she had set out a “clear economic plan, with robust fiscal rules, that gets debt falling, balances the current budget within three years, while responsibly delivering the investment this country needs to support growth”.
The market reaction fed through to interest rate swaps, which brokers said were likely to slow recent months’ decline in UK mortgage rates.
Two-year interest rate swaps — which are closely watched because of the prevalence of two-year fixed-rate mortgages — climbed to 4.5 per cent, up from 4.3 per cent before the Budget and less than 4 per cent in mid-September. Five-year swaps have also risen, reaching 4.3 per cent.
Simon Gammon, managing partner at Knight Frank Finance, said that any further falls in mortgages rates would be “on hold” for the time being and that some lenders might “notch up” rates in the weeks ahead to defend their margins.
“That said, this won’t result in a big change in the trajectory of mortgage rates — at least not if the current bond market volatility remains in check,” Gammon said.
Additional reporting by Robert Wright, Ian Smith and Akila Quinio
