Markets react to the Budget's good, bad and ugly

The market reaction to the 2024 Autumn Budget wasn’t another “mini” Budget meltdown. But it’s safe to say that it wasn’t what the chancellor was hoping for, either.

The chancellor used her first fiscal event as an opportunity to showcase her commitment to supporting UK economic institutions and to balancing the books. News that Rachel Reeves was on track to meet both of her fiscal rules early mollified investors, as did figures from the Office for Budget Responsibility (OBR) fiscal watchdog suggesting that net financial debt would fall as a proportion of GDP by 2027-28. As the chart below shows, 10-year gilt yields initially dropped as Reeves delivered the Budget.

The chancellor also took pains to lend her support to UK economic institutions, thanking staff at the Bank of England for their work, and stressing the importance of the OBR. This, crucially, set a very different tone to Liz Truss and Kwasi Kwarteng in 2022. Between them, the duo questioned the independence of the Bank of England (BoE) while sidelining OBR forecasts completely.

That was the good that Reeves managed, but what about everything else?

The bad: Inflation

But once Reeves sat down, the OBR’s economic and fiscal outlook was released. This gave investors a lot to chew over. The watchdog expects the policies announced in the Budget to push inflation up to 2.6 per cent in 2025 before it falls back to target later on. As a result, the OBR sees a higher path for interest rates and raised its forecasts by 0.25 percentage points for the next five years. As markets digested this news, the 10-year gilt yields started to climb, reaching around 4.5 per cent in the days after the Budget was announced, as the chart above shows. 

You could be forgiven for thinking that this had uncomfortable echoes of Truss and Kwarteng’s ill-fated stimulus package: an inflationary demand injection, leading to a recalibration of interest rate expectations. But in 2022, inflation was in double digits and still rising. Today, inflation is below the 2 per cent target and the BoE is cutting rates. Thanks to the very different economic backdrops, an echo is all it is. 

The ugly: growth 

A deeper dive into the OBR report also reveals some unpalatable forecasts for economic growth and the chancellor’s ‘headroom’ against her fiscal rules. The watchdog expects the Budget measures to trigger higher growth in the short term, but leave GDP largely unchanged in five years. 

This is unhelpful for Reeves, who is targeting debt as a share of GDP with her second fiscal rule. According to OBR projections, Reeves will meet the rule, but will be left with a very narrow buffer of £15.7bn by 2029. The OBR warns that this headroom is vulnerable to changing forecasts. Worryingly, interest rates overshooting by as little as 1.3 per cent could wipe it out entirely. 

The unrelated: US election jitters and fading recession fears 

The Budget gave markets plenty to digest: stickier inflation, higher for longer interest rates and a still-precarious public finance position. Yet it is worth stressing that it wasn’t the only thing driving gilt yields last week. Positive US GDP figures reduced fears of a recession but increased interest rate expectations – meaning Treasury yields climbed, too. The US election this week could also trigger huge (unrelated) volatility in bond markets over the days ahead. 

Simon French, chief economist at Panmure Liberum, points out that the Budget leaves the UK’s debt stock and tax burden both looking “mid-range” by G7 standards. As a result, he said that “UK sovereign debt is not an outlier, nor deserving of especially adverse treatment”. Even if yields jump again this week, this is not a repeat of the “mini” Budget fallout.