Rachel Reeves faces £10billion Budget blow as US-Iran war rattles bond markets
The Middle East conflict has obliterated up to £10billion from Rachel Reeves’ fiscal buffer in barely seven days, as surging borrowing costs wreak havoc on Britain’s public finances.
Expectations that interest rates will remain elevated for longer have triggered a significant sell-off in UK Government bonds, with investors growing increasingly nervous about the crisis.
Rising oil and gas prices linked to the conflict have fuelled concerns that inflation will prove stickier than anticipated, dashing hopes of imminent rate cuts from the Bank of England.
Just weeks ago, markets anticipated two rate reductions this year beginning imminently. Those expectations have now vanished entirely, with some traders positioning for a potential rate increase instead.
Yields on ten-year gilts climbed to nearly 4.8 per cent yesterday, marking a six-month peak, before retreating to just above 4.6 per cent.
Two-year gilts, which track interest rate expectations most closely, jumped beyond 4.2 per cent to levels not witnessed in almost twelve months.
Sanjay Raja at Deutsche Bank estimated the recent market turbulence has stripped between £7billion and £10billion from the Chancellor’s fiscal room for manoeuvre.
The timing proves particularly painful for Ms Reeves as by late last month, ten-year yields had drifted down to roughly 4.2 per cent, their lowest point since December 2024.
This had enabled her to announce in last week’s Spring Statement that headroom had risen modestly from £21.7billion at November’s Budget to £23.6billion.
Sanjay Raja at Deutsche Bank estimated the recent market turbulence has stripped between £7billion and £10billion from the Chancellor’s fiscal room for manoeuvre
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The British Chambers of Commerce has slashed its UK growth prediction for this year to one per cent, down from an earlier forecast of 1.2 per cent.
Inflation prospects have also deteriorated, with consumer prices expected to remain at 2.7 per cent by year’s end rather than reaching the Bank of England’s two per cent target.
David Bharier, head of research at the BCC, said the risks around the war in Iran were “interrupting progress” on inflation.
Lloyds Bank said a roughly 2.5 percentage-point rise in inflation would wipe out the Government’s 23.6 billion-pound ($31.4 billion) fiscal headroom
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PA“Higher energy prices linked to it could keep inflation firmly above the two per cent target and lead the Bank of England to hold the interest rate longer than expected,” Bharier said.
“Much depends on the duration of the conflict.”
Lloyds Bank said a roughly 2.5 percentage-point rise in inflation would wipe out the government’s 23.6 billion-pound ($31.4 billion) fiscal headroom,
The bond market turmoil has proved more severe in Britain than across other advanced economies, with the fragile condition of public finances under Labour leaving them particularly exposed.
Speculation about a potential Government intervention to shield households from soaring energy bills has intensified market anxiety.
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GETTYSpeculation about a potential Government intervention to shield households from soaring energy bills has intensified market anxiety.
Prime Minister Keir Starmer’s statement yesterday that “supporting working people and their families with the cost of living is always top of my mind” did little to quell such concerns.
The situation carries uncomfortable parallels with Liz Truss’s brief tenure, when a substantial bailout prompted by the energy crisis at the outbreak of the Ukraine war contributed to a damaging bond market rout.
