With Treasury yields soaring, Reeves must carefully stay ahead of the budget

Rachel Reeves must exercise caution ahead of the Budget if Britain is to avoid another bond market crash, economists have warned.

The rising cost of government borrowing over the past month has raised fears that bond markets will punish the country already before October 30, with many people still feeling the effects of the disastrous September 2022 budget.

Yields on two-, five- and 10-year British government bonds rose by 40, 47 and 45 basis points respectively last month as investors shed exposure to British debt.

Bond yields have risen since the general election, while elsewhere, the US, France and even struggling Germany have seen their government bond yields fall.

Panmure Liberum economist Simon French said: “Given the experience of the mini-budget in September 2022, when Gilt bond yields saw a similar decoupling from bond volumes – albeit in the context of rising inflation and interest rates around the world – there is understandable concern about in connection with the repetition.

However, the Frenchman said the current strength of sterling – $1.31 today compared to a low of $1.08 in 2022 – shows that “the appetite for British state assets” does not “have a similar waning moment”.

He added: “There have been a number of geopolitical crosswinds that have contextualized this move in government bond yields, including UK economic data which has remained exceptionally solid in recent months.

“It would not be an unreasonable interpretation of the recent move in government bond yields to say that it is a reaction to a reflationary increase in growth expectations for the UK compared to the UK's international peers.

“Likewise… the Bank of England did so by adopting a more hawkish tone than its international central bank counterparts, both in terms of its short-term forecasts for UK interest rates and its active sale of sovereign debt back to the open market.”

However, the pound is now much stronger than it was in 2022, showing that investors are not entirely negative about the UK

Bond yields have risen since the UK general election, while other overseas investors have seen borrowing costs plummet

Bond yields surged in the wake of the Truss-Kwarteng budget as investors reacted to a series of unfunded tax cuts, with the 30-year bond yield rising 120 basis points in just three days.

The gains over the past month have significantly narrowed the gap between current yields and the 2022 peak, but the gap still exists.

The 10-year government bond yield peaked at 4.338 percent in the wake of the Truss-Kwarteng budget, down from a current level of around 4.2 percent, although the difference largely reflects interest rate cuts.

Reeves felt positive after Friday's data showed the British economy strengthened in August

The Frenchman warned that a “cautious approach to the next three weeks is crucial” for the treasury, which must show investors that its spending plans will not be overly inflationary.

Peel Hunt chief economist Kallum Pickering said: “With a deficit of 3 to 4 per cent of GDP and public debt at almost 100 per cent, Reeves has little room for maneuver no matter how he tries to frame the economic and fiscal situation.”

He added that Reeves' decision in July to strengthen the OBR's powers had “helped, but only marginally” and that rumors of changes to the government's fiscal rules allowing more borrowing to finance investment could have a minimal impact.

Pickering said: “While these adjustments better target fiscal policy to support long-term growth and may create space for additional investment, they ultimately amount to accounting acrobatics.

“The UK's fiscal obligations remain the same regardless of how they are counted.”

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