Chancellor's emotional journey braced for further turmoil
In the political and financial landscape of the UK, the fiscal stance of the current Labour government, under Chancellor Rachel Reeves, has become a subject of significant debate and concern. The recent reversal of welfare reforms and internal party rebellion has introduced a level of political and fiscal uncertainty that is causing ripples in UK markets, particularly in the gilt and bond markets.
Labour's focus on promoting economic growth has been met with challenges and internal divisions, particularly over welfare reform. In June 2025, the government reversed its planned welfare reforms designed to save £5 billion annually, a move that has undermined investor confidence in Labour’s ability to deliver long-term fiscal consolidation.
This U-turn has eroded trust in Labour’s fiscal discipline, leading to higher yields on UK government gilts as investors demand higher compensation for the increased risk. As gilt yields rise, existing bond prices fall, reflecting increased volatility and risk premia in the bond market.
Market participants are concerned about the sustainability of the public finances given Labour's recent policy backtracking and the challenge of balancing growth ambitions with fiscal responsibility. The broader UK economic strategy, as outlined in recent government spending reviews, emphasizes cost-consciousness and a zero-based spending review approach to ensure value for money. However, Labour’s recent welfare policy reversal contrasts with these aims, further complicating market perceptions.
The increased uncertainty and perceived fiscal inconsistency have led to concerns in the UK gilt and bond markets. For instance, the yield on the 30-year-long bond has jumped by 0.64 of a percentage point to 5.33 percent in the past 12 months. A funding gap of that size cannot be resolved by small shifts in secondary taxes such as a bank levy or punishing wealth.
L&G, one of the biggest UK asset managers, has expressed concern about a lack of clarity in the Government's fiscal stance, which has unsettled markets. A possible move to introduce a surcharge on corporation tax could negatively impact business confidence, further exacerbating the situation.
Economic forecasting firm Oxford Economics predicts that U-turns on welfare and winter fuel, along with possible revisions to Office for Budget Responsibility growth assumptions, have created a funding gap of £20billion to £30billion that needs to be closed in the autumn. This financial turmoil is expected to be particularly challenging for the Chancellor during the summer of 2023.
The surge in gilt yields is being used as evidence by Labour apparatchiks that financial markets believe in the Chancellor's control over public finances. However, the closure of banks like NatWest in towns such as Abingdon laments the impact on local communities.
Meanwhile, across the Atlantic, the US has passed a tax and spending bill that reinstates tax cuts for the better off and increases spending on defense and border security, while cutting benefits for the less well-off and elderly. This bill is estimated to add $3.4 trillion to the national debt over the next decade.
In the face of these challenges, the Chancellor may need to tap into larger sources of government income, potentially violating manifesto promises. This, coupled with the potential for a surcharge on corporation tax, could further negatively impact business confidence and market stability.
- The recent policy backtracking by the Labour government, including the reversal of welfare reforms, has led to an increase in the yields on UK government gilts, as investors demand higher compensation for the increased risk.
- Market participants are worried about the sustainability of the public finances given the fiscal inconsistency shown by Labour, and the challenge of balancing growth ambitions with fiscal responsibility.
- The increased uncertainty and perceived fiscal inconsistency have led to concerns in the business community, with one of the biggest UK asset managers, L&G, expressing concern about a lack of clarity in the Government's fiscal stance.
- The funding gap created by Labour's recent welfare policy reversal and U-turns on other policies is expected to be particularly challenging for the Chancellor, with economic forecasting firm Oxford Economics predicting a funding gap of £20billion to £30billion that needs to be closed in the autumn.
