UK government bonds sell off as Kwarteng unveils tax cuts

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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.

Ten-year Treasury yields rose 0.2 percentage point to 3.699 percent, bringing the gain for the week to half a percentage point. According to data from Refinitiv, this marks the largest increase in long-term borrowing costs since 1998. Two-year government bond yields have risen more than 0.7 percentage points this week.

The heavy sale in gilts on Friday came after Kwarteng said the government would scrap the top 45p income tax rate and replace it with a 40p rate. He also announced a reduction in stamp duty on home sales.

The tax cuts, which will reduce government revenues, come as the UK is expected to spend £150 billion on subsidizing energy costs for consumers and businesses. Kwarteng said the energy bailout would cost £60 billion in the first six months.

A large part of this loan will have to be financed by the sale of gilts. The UK Debt Management Office increased its planned bond sales for fiscal year 2022-23 by £62.4 billion to £193.9 billion.

“This is an escalation of the dramatic sell-off that we have already seen in the gold market over the past two months,” said Antoine Bouvet, fixed income strategist at ING. “There are a lot of tax cuts on top of the energy price guarantee, which deters gold-plated investors who now see a ton more issuance coming.”

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

In currencies, the pound slipped to a new 37-year low against the dollar on Thursday. Sterling fell as much as 0.9 percent as Kwarteng spoke, hitting a low of $1,1151, a level last seen in 1985, according to data from Refinitiv.

The decline came as the dollar continued its rally against currencies around the world, two days after the Federal Reserve raised its interest rate by 0.75 percentage points for the third consecutive meeting to curb rising inflation. The BoE opted for a 0.5 percentage point gain on Thursday, smaller than many investors had expected.

“In this kind of environment with the cost of living crisis, energy crisis. . . the likelihood of policy slippage is increasing,” said Stephen Gallo, head of European FX at BMO Capital Markets. “The coin will show a lot of the burden and it is doing so now.”

The pound rose 0.1 percent against the euro.

“We see continued downward pressure on the pound,” said Derek Halpenny, European head of research at MUFG, adding that Kwarteng’s package of tax cuts and spending is unlikely to lead to a recovery. “That fiscal expansion doesn’t seem sustainable, as the BoE tightening falls short of half of the G10’s central banks, despite the UK having the highest inflation rate in the G10.”