Why the financial market mood has shifted against the UK

Published

6 months ago

January 10, 2025

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As the dust settles on a tumultuous week for gilts (UK government bonds) and sterling – a week that has raised serious questions about chancellor Rachel Reeves’s stewardship of the economy – the big question many people will be asking is why investor sentiment has shifted so much against the UK in the past week.

Following on from that is what Ms Reeves should try to do about it.

The first point to make – and indeed it is one the government has been making – is that there has been a broad sell-off in government bonds around the world this week. Yields, which go up as the price of a bond falls, have been rising not only in the case of gilts but also on bonds issued by the likes of the US, Japan, France and Germany.

That reflects the fact that investors are changing their assumptions about the path of inflation this year and, in turn, how central banks like the US Federal Reserve, the European Central Bank and the Bank of England respond.

Money latest: Pound hit steadies as chancellor considers spending cuts

Inflation is now expected to be stickier around the world due to a combination of factors, of which by far the biggest is the tariffs the incoming Trump administration is expected to introduce. Those tariffs will push up the price of goods bought by American consumers and, if America’s trading partners respond with tariffs of their own, for consumers elsewhere. US Treasuries have also been under pressure due to expectations that Mr Trump will raise US borrowing sharply.

That said, gilt yields have been rising by more than yields on their international counterparts, reflecting the fact that investors think the UK has specific issues with inflation. The increase in employer’s national insurance contributions (NICs) announced by Ms Reeves in her Halloween budget will be highly inflationary because they will push up the cost of employing people.

The chief executives of some of the UK’s biggest retailers – Lord Wolfson at Next, Ken Murphy at Tesco, Stuart Machin at Marks & Spencer and Simon Roberts at Sainsbury’s – this week repeated their warnings that these higher costs will feed through to higher prices.

Another reason why gilt yields have risen more than those of their international counterparts is the UK’s particular fiscal position and its poor growth prospects.

Yes, other countries have as poor prospects for growth as the UK or as bad a debt situation. The US national debt, for example, is 123% of US GDP while Japan has a debt to GDP ratio of 250%. The UK, with a debt to GDP ratio of just under 99%, doesn’t look so bad by comparison. However, as the market in US Treasuries is the biggest and most liquid in the world and the US dollar is the global reserve currency, investors seldom have hesitation about lending to the US government. Similarly, in the case of Japan, most of its government debt is owned by Japanese savers – encapsulated by the mythical figure of ‘Mrs Watanabe’.

The UK does not have that luxury and, accordingly, has to rely on what Mark Carney, the former governor of the Bank of England, memorably described in a 2017 speech as “the kindness of strangers” to fund its borrowing (he was talking on that occasion about the UK’s current account deficit rather than its fiscal deficit, but the point holds).

In summary, then, investors are demanding a higher premium for the added risk of holding gilts. That perceived risk – as the former prime minister Liz Truss has gleefully been pointing out – means that yields on some gilts are now even higher than they spiked following her chancellor Kwasi Kwarteng’s ill-fated mini budget in September 2022.

Investors are also sceptical about the UK economy’s ability to grow its way out of this predicament. While the government’s proposals to invest in infrastructure have been welcomed by investors, they have also noted that much of the extra borrowing being taken on by Ms Reeves in her budget was to fund big pay rises for public sector workers, which – rightly or wrongly – are not perceived to be as good a use of government money as, say, investing in improvements to roads or power grids.

So what does Ms Reeves do?

Well, as the old joke about the Irishman guiding a lost tourist puts it, she “wouldn’t start from here”. The chancellor’s big mistake was to box herself in during the general election campaign by ruling out increases in income tax, employees’ national insurance, VAT or corporation tax. She could easily, for example, have promised to unwind her predecessor Jeremy Hunt’s cut in employee’s national insurance – which was rightly recognised by most voters as a pre-election bribe.

Still, she is where she is, so the chancellor’s main job now will be to convince investors that the UK is on a stable fiscal footing. With the recent rise in gilt yields – the implied government borrowing cost – threatening to eliminate the chancellor’s headroom to meet her fiscal rules, that is likely to mean public sector spending cuts or higher taxes. The former option is more likely than the latter and not least because Ms Reeves is committed to just one ‘fiscal event’ – when taxes are raised – per year and that will be her budget this autumn.

The Bank of England is also going to have a big part to play here in reinforcing to markets its determination to bringing inflation down to its target range – which means borrowers should not expect as many interest rate cuts in 2025 as they were, say, six months ago.

The Bank may also slow the pace at which it is selling its own gilt holdings (accumulated largely during the ‘quantitative easing’ on which it embarked after the global financial crisis) which would also ease the downward pressure on gilts.

Also coming to the chancellor’s aid, in all likelihood, will be a weakening in the pound which should, all other things being equal, help make gilts more appetising to international investors.

All of this underlines though, unfortunately, that there is only so much the chancellor can do.

Business

UK economy figures not as bad as they look despite GDP fall, analysts say

Published

22 hours ago

July 11, 2025

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UK economy figures not as bad as they look despite GDP fall, analysts say

The UK economy unexpectedly shrank in May, even after the worst of Donald Trump’s tariffs were paused, official figures showed.

A standard measure of economic growth, gross domestic product (GDP), contracted 0.1% in May, according to the Office for National Statistics (ONS).

Rather than a fall being anticipated, growth of 0.1% was forecast by economists polled by Reuters as big falls in production and construction were seen.

It followed a 0.3% contraction in April, when Mr Trump announced his country-specific tariffs and sparked a global trade war.

A 90-day pause on these import taxes, which has been extended, allowed more normality to resume.

This was borne out by other figures released by the ONS on Friday.

Exports to the United States rose £300m but “remained relatively low” following a “substantial decrease” in April, the data said.

Overall, there was a “large rise in goods imports and a fall in goods exports”.

A ‘disappointing’ but mixed picture

It’s “disappointing” news, Chancellor Rachel Reeves said. She and the government as a whole have repeatedly said growing the economy was their number one priority.

“I am determined to kickstart economic growth and deliver on that promise”, she added.

But the picture was not all bad.

Growth recorded in March was revised upwards, further indicating that companies invested to prepare for tariffs. Rather than GDP of 0.2%, the ONS said on Friday the figure was actually 0.4%.

It showed businesses moved forward activity to be ready for the extra taxes. Businesses were hit with higher employer national insurance contributions in April.

The expansion in March means the economy still grew when the three months are looked at together.

While an interest rate cut in August had already been expected, investors upped their bets of a 0.25 percentage point fall in the Bank of England’s base interest rate.

Such a cut would bring down the rate to 4% and make borrowing cheaper.

Analysts from economic research firm Pantheon Macro said the data was not as bad as it looked.

“The size of the manufacturing drop looks erratic to us and should partly unwind… There are signs that GDP growth can rebound in June”, said Pantheon’s chief UK economist, Rob Wood.

Why did the economy shrink?

The drops in manufacturing came mostly due to slowed car-making, less oil and gas extraction and the pharmaceutical industry.

The fall was not larger because the services industry – the largest part of the economy – expanded, with law firms and computer programmers having a good month.

It made up for a “very weak” month for retailers, the ONS said.

Business

UK economy remains fragile – and there are risks and traps lurking around the corner

Published

22 hours ago

July 11, 2025

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UK economy remains fragile - and there are risks and traps lurking around the corner

Monthly Gross Domestic Product (GDP) figures are volatile and, on their own, don’t tell us much.

However, the picture emerging a year since the election of the Labour government is not hugely comforting.

This is a government that promised to turbocharge economic growth, the key to improving livelihoods and the public finances. Instead, the economy is mainly flatlining.

Output shrank in May by 0.1%. That followed a 0.3% drop in April.

Ministers were celebrating a few months ago as data showed the economy grew by 0.7% in the first quarter.

Hangover from artificial growth

However, the subsequent data has shown us that much of that growth was artificial, with businesses racing to get orders out of the door to beat the possible introduction of tariffs. Property transactions were also brought forward to beat stamp duty changes.

In April, we experienced the hangover as orders and industrial output dropped. Services also struggled as demand for legal and conveyancing services dropped after the stamp duty changes.

Many of those distortions have now been smoothed out, but the manufacturing sector still struggled in May.

Signs of recovery

Manufacturing output fell by 1% in May, but more up-to-date data suggests the sector is recovering.

“We expect both cars and pharma output to improve as the UK-US trade deal comes into force and the volatility unwinds,” economists at Pantheon Macroeconomics said.

Meanwhile, the services sector eked out growth of 0.1%.

A 2.7% month-to-month fall in retail sales suppressed growth in the sector, but that should improve with hot weather likely to boost demand at restaurants and pubs.

Struggles ahead

It is unlikely, however, to massively shift the dial for the economy, the kind of shift the Labour government has promised and needs in order to give it some breathing room against its fiscal rules.

The economy remains fragile, and there are risks and traps lurking around the corner.

Concerns that the chancellor, Rachel Reeves, is considering tax hikes could weigh on consumer confidence, at a time when businesses are already scaling back hiring because of national insurance tax hikes.

Inflation is also expected to climb in the second half of the year, further weighing on consumers and businesses.

Business

Government to announce new scheme as it ramps up AI adoption with backing from Facebook owner Meta

Published

1 day ago

July 11, 2025

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Government to announce new scheme as it ramps up AI adoption with backing from Facebook owner Meta

The government is speeding up its adoption of AI to try and encourage economic growth – with backing from Facebook parent Meta.

It will today announce a $1m (£740,000) scheme to hire up to 10 AI “experts” to help with the adoption of the technology.

Sir Keir Starmer has spoken repeatedly about wanting to use the developing technology as part of his “plan for change” to improve the UK – with claims it could produce tens of billions in savings and efficiencies.

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The government is hoping the new hires could help with problems like translating classified documents en masse, speeding up planning applications or help with emergency responses when power or internet outages occur.

The funding for the roles is coming from Meta, through the Alan Turing Institute. Adverts will go live next week, with the new fellowships expected to start at the beginning of 2026.

Technology Secretary Peter Kyle said: “This fellowship is the best of AI in action – open, practical, and built for public good. It’s about delivery, not just ideas – creating real tools that help government work better for people.”

He added: “The fellowship will help scale that kind of impact across government, and develop sovereign capabilities where the UK must lead, like national security and critical infrastructure.”

The projects will all be based on open source models, meaning there will be a minimal cost for the government when it comes to licensing.

Meta describes its own AI model, Llama, as open source, although there are questions around whether it truly qualifies for that title due to parts of its code base not being published.

The owner of Facebook has also sponsored several studies into the benefits of government adopting more open source AI tools.

Mr Kyle’s Department for Science and Technology has been working on its mission to increase the uptake of AI within government, including through the artificial intelligence “incubator”, under which these fellowships will fall.

The secretary of state has pointed to the success of Caddy – a tool that helps call centre workers search for answers in official documents faster – and its expanding use across government as an example of an AI success story.

He said the tool, developed with Citizens Advice, shows how AI can “boost productivity, improve decision-making, and support frontline staff”. A trial suggested it could cut waiting times for calls in half.

My Kyle also recently announced a deal with Google to provide tech support to government and assist with modernisation of data.

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Joel Kaplan, the chief global affairs officer from Meta, said: “Open-source AI models are helping researchers and developers make major scientific and medical breakthroughs, and they have the potential to transform the delivery of public services too.

“This partnership with ATI will help the government access some of the brightest minds and the technology they need to solve big challenges – and to do it openly and in the public interest.”

Jean Innes, the head of the Alan Turing Institute, said: “These fellowships will offer an innovative way to match AI experts with the real world challenges our public services are facing.”