Chancellor facing tough questions over fiscal rules as market woes deepen

The pound has remained under pressure amid an intensifying sell-off in government bonds as Chancellor Rachel Reeves faces mounting questions over her fiscal rules.

Sterling fell another 0.5% to 1.214 US dollars on Monday, having last week hit its lowest level against the dollar since November 2023, with government borrowing costs rising ever higher.

UK government bonds – also known as gilts – continued to see 10-year yields hit fresh highs not seen 2008, up six basis points at 4.9%.

The yield on 30-year gilts also hit new 27-year highs, up five basis points at 5.5%.

Yields move inversely to bond prices.

The Chancellor returned from her trip to China as concerns swirled that the Government is in danger of failing to meet its own fiscal rules and will need to take action to remain on track.

Woes

Ms Reeves insisted over the weekend that her fiscal rules are “non-negotiable”.

Speaking to reporters while in Beijing, where she was seeking to rebuild economic ties with China, she pledged to “take action to ensure that we meet those fiscal rules”.

Increases in the Government’s borrowing costs have sparked concern that she will be unable to meet her debt and spending targets, requiring either tax rises or deeper spending cuts when she delivers a fiscal statement at the end of March.

Some traders fear a deepening slump for the pound, which has been hit hard by the gilt market woes, as well as stubborn inflation, high government borrowing and concerns over incoming US president Donald Trump and his plans for tariffs on overseas trade.

Sterling’s weakness has been compounded by a stronger dollar, as markets see fewer interest rate cuts coming down the line.

Official figures due on Wednesday are set to show another rise in UK inflation, which could deepen the pound’s troubles.

Prime Minister Sir Keir Starmer is also throwing the Government’s weight behind artificial intelligence (AI) in a bid to boost growth.

Spending

But markets are yet to be convinced and there are worries over a knock-on effect on mortgages and pensions from the gilt market rout.

Critics have drawn parallels with the fallout from former prime minister Liz Truss’s disastrous 2022 mini-budget, when the pound was sent crashing due to an acute sell-off in gilts.

Kathleen Brooks, research director at XTB, said worries over UK government debt levels will not go away until the Government announces measures or spending cuts to address it.

She said: “The bond market is attempting to intimidate Chancellor Rachel Reeves into forcing the UK to live within its means.

“We think the bond market will get its way.

“The Labour Government may well get the UK on a secure fiscal footing, but it may not do it in the way it had wished for when it came to power last year.

“In 2025, public sector spending is out. Rachel Reeves needs to acknowledge this before the bond market will calm down.”

The increase in the cost of servicing Government debts is seen cutting into Labour’s already slim £9.9 billion financial headroom.

The Chancellor has previously ruled out both increasing borrowing and raising taxes following the significant tax increases in October’s Budget, leaving her with few options beyond further spending cuts.

But it is not thought the UK is facing a Liz Truss moment just yet, with the levels of volatility in markets not on the scale of the panic-driven sell-off seen in 2022, and the pound in a stronger position that it was then, when it crashed to its lowest level against the dollar since 1985.