Bond fund managers are increasingly skeptical chancellor Rachel Reeves will stay within the “nonnegotiable” fiscal rules she committed to less than a year ago.
Already on high alert after the announcement of US tariffs on global economies, rising national debt and sticky domestic inflation, some fear there could be another showdown between the UK gilts market and the government in the offing—and all within a year of the Labour administration taking office. This anxiety is being reflected in longer-term bond yields, which are increasing government borrowing costs at a time when economic pressures are mounting on all sides.
Their comments come as the International Monetary Fund (IMF) suggests Reeves could reduce the number of Office for Budget Responsibility assessments of the UK’s fiscal rules from two to one per year, potentially giving the chancellor cover to make more significant adjustments to fiscal policy. While all that is debated ahead of October’s Autumn Budget, bond managers sound increasingly concerned.
“In the current state of affairs, it is very unlikely that the chancellor will meet her fiscal rules,” says Neil Mehta, portfolio manager within the investment-grade team at RBC BlueBay Asset Management.
“Borrowing has overshot by £50 billion since the [2024] election and needs to be reined in, but it seems the government has done little to address this key market concern and abandoned any attempt to look fiscally credible.”
Long-Term Bond Yields Have Soared
UK bonds with longer maturities have seen the biggest increase in yields: the 10-year gilt now yields 4.71%, 20 basis points higher than last month and 43 basis points higher than this time last year. This move is more pronounced with 30-year bonds, which are 19 basis points higher than in April and 72 basis points higher than in 2024.
Advanced economies like the US, Japan and Germany have seen steep increases in 30-year yields as investors reassess the risk of long-term lending to governments. Rising yields are a function of falling prices, which occur when investors sell bonds.
This increase in long-term UK bond yields is not a very recent trend either—there was a spike in yields at the start of 2025 as investors fretted about the government’s fiscal plans ahead of the Spring Statement in March. While this event calmed some bond market fears, the 30-year yield is actually higher than in January, and is at levels last seen in the late 1990s.
Shorter-term UK government bond yields have risen in the past month too, reflecting changed market perceptions of the path of interest rates, especially after April’s strong inflation print. While two-year gilt yields are 44 basis points lower than a year ago, taking into account the cuts in interest rates since then, the yield is up 20 basis points in a month to 4.05%. This is below the current Bank Rate of 4.25%.
Year to date the Morningstar UK Bond Index is up nearly 10%, reflecting the price increases at the shorter end of the yield curve.
Why Are Bond Managers Concerned About Government Spending?
Keir Starmer and Rachel Reeves have committed to a lot of policies: lowering inflation; improving GDP growth; sealing post-Brexit (and tariff) trade deals; raising defense budgets; building millions of houses; and decreasing NHS waiting times all pile high in the in-tray.
Together these policies will cost billions.
Meanwhile, the government’s existing commitments are already getting more expensive because of a poorer economic outlook and higher borrowing costs. This eats into the “fiscal headroom” the chancellor needs to fund new government commitments.
In the lead up to the Spring Statement in March, Reeves said there would be no new tax increases after she launched £40 billion of tax hikes in her first Budget in October 2024. But as the Autumn Budget approaches, experts are already predicting an increase in either the headline rate of VAT, National Insurance, or income tax, which would be a breach of Labour’s 2024 manifesto commitments.
“It is pretty much inevitable now that she will have to raise one of those big taxes,” Stephen Millard, acting director of the National Institute of Economic and Social Research (NIESR), said.
For bond investors, public sector borrowing is a big concern. That totaled £16.44 billion in March, up from £12.31 billion in February, and higher than £12.7 billion the year before. In April, monthly government borrowing rose to £20.2 billion, surpassing analyst predictions of £17.6 billion.
“Recent policy actions—the reversal of winter fuel payments, above-inflation public sector pay awards, watering down the two-child benefit cap, and the deal with the Chagos Islands—all require extra cash via increased borrowing or further cuts to spending,” BlueBay’s Mehta says.
“At the same time, borrowing costs continue to remain at elevated levels as inflation struggles to come down meaningfully. With the 30-year gilt yield above 5.4%, investors are now accepting the new reality of elevated risk premium attached to lending to the UK government.”
And some are not convinced tax rises are an easy quick fix.
“The government cannot talk its way out of problems it has spent its way into; nor am I convinced that it can tax its way out,” says Gordon Shannon, portfolio manager at TwentyFour Asset Management.
“The solution the market wants to see is lower government spending, especially in areas where the second-order impacts are typically reduced labor participation and productivity.”
What Are The Labour Government’s Fiscal Rules?
When Labour took office in July last year, it committed to so-called “fiscal rules,” which dictate the financial constraints the government must work with while in office.
The first rule means government budgets must be in balance or surplus by 2029/30, at which point the Treasury should only borrow to invest.
The second rule means net financial debt should fall as a share of the economy by 2029/30. At the end of April, the UK’s public sector net debt was equivalent to 95.5% of gross domestic product.
The third puts constraints on certain types of social security spending. State pension payments and allowances considered more sensitive to periods of economic disruption—such as Jobseeker’s Allowance—are excluded from this.
Bond investors and analysts look at the government’s ability to stick to these rules to assess the likelihood of it repaying its debts to investors.
One problem is forecasting uncertainty. It is generally very difficult to tell precisely how much the government will need to borrow month to month. Sometimes the unexpected happens and outcomes deviate from forecasts.
In February, the Office For National Statistics said there had been a public sector net borrowing surplus in January, of £15.44 billion. It was the largest since monthly records began in 1993 and happened because of higher-than-expected tax returns.
Will The ISA Allowance Be Cut?
As concerns have mounted over the government’s strained finances, so too has speculation that savings allowances could be cut to fund its other commitments.
Among them is the annual £20,000 ISA savings allowance, which permits savers to put a maximum of £20,000 in a range of different ISA products, including cash and stocks.
Amid this speculation, the chancellor has committed to keeping the allowance overall, but commentators still expect there could be a new limit on the amount savers may specifically put in cash products—a policy supposedly aligned with the government’s objective of encouraging economic growth via pensions and savings reform.
“It’s good news she has committed to keeping the overall ISA limit of £20,000—ISAs are one of the most popular ways for Brits to save and invest for their future and cutting that limit would have hit many people hard,” says Rachel Vahey, head of public policy at AJ Bell.
“But this commitment doesn’t necessarily mean the idea of a lower allowance for only cash ISAs is off the table. The Treasury will be looking at a range of solutions in their quest to get a better balance between cash and equities in ISAs.”
Keir Starmer vs Tony Blair
By May 1998, after a year in office, Prime Minister Tony Blair faced accusations he had just not done enough to move Labour’s policy agendas forward.
He could at least count Bank of England independence, the minimum wage, constitutional reform, devolution, and progress in the Northern Ireland peace process among his government’s achievements.
The first anniversary of Keir Starmer’s administration is unlikely to look quite as positive. Bond markets will be watching.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
