UK government bonds sell off as Kwarteng unveils tax cuts

UK government bonds fell sharply on Friday as investors braced for a flood of new debt sales to fund chancellor Kwasi Kwarteng’s package of tax cuts and energy subsidies.

The 10-year gilt yield soared 0.2 percentage points to 3.699 per cent, bringing its rise for the week to half a percentage point. It marks the biggest increase in long-term borrowing costs since 1998, according to Refinitiv data. Two-year gilt yields have lurched more than 0.7 percentage points higher this week.

Friday’s heavy selling in gilts came after Kwarteng said the government would scrap the 45p top rate of income tax, replacing it with a 40p rate. He also announced a cut in stamp duty on home sales.

The tax cuts, which will reduce government income, come as the UK is expected to spend £150bn on subsidising energy costs for consumers and businesses. Kwarteng said the energy rescue scheme would cost £60bn in its first six months.

A large swath of this borrowing will need to financed by selling gilts. The UK Debt Management Office increased its planned bond sales for the 2022-23 fiscal year by £62.4bn to £193.9bn.

“This is an escalation of the dramatic sell-off we’ve already seen in the gilt market over the past two months,” said Antoine Bouvet, a fixed-income strategist at ING. “There are a lot of tax cuts coming on top of the energy price guarantee, and that’s scaring gilt investors who now see a tonne more issuance coming.”

Bouvet said markets were also anticipating more aggressive interest rate rises from the Bank of England to offset the inflationary impact of Kwarteng’s stimulus measures.

In currencies, the pound slid to a fresh 37-year low against the dollar on Thursday. Sterling fell as much as 1.6 per cent after Kwarteng spoke, hitting a low of $1.1078, a level last seen in 1985, according to Refinitiv data.

The decline came as the dollar continued its rally against currencies across the globe, two days after the Federal Reserve lifted its interest rate by 0.75 percentage points for the third consecutive meeting as it bids to tame soaring inflation. The BoE opted for a 0.5 percentage point rise on Thursday, smaller than many investors had expected.

“In this type of environment with the cost of living crisis, energy crisis . . . the chance for policy missteps rises,” said Stephen Gallo, head of European FX at BMO Capital Markets. “The currency is going to show a lot of the burden and it is doing that now.”

Against the euro, the pound rose 0.1 per cent.

“We see continued pressure to the downside for the pound,” said Derek Halpenny, European head of research at MUFG, adding that Kwarteng’s package of tax cuts and spending was unlikely to spur a rebound. “That fiscal expansion does not look sustainable while the BoE’s tightening lags behind half of the G10 central banks despite the UK having the highest inflation across G10.”