What will the budget mean for bonds?

The recent recovery in the gilts market has been unsettled by fears of more government borrowing - but have they been overplayed?

As next week’s budget has loomed into view, speculation about the new government’s intentions has swelled, roiling markets with fears of tax rises and unchecked borrowing.

So much so that Chancellor Rachel Reeves has taken the unusual step of confirming in advance of Wednesday’s statement that, as widely anticipated, the government will rewrite the UK’s debt rules to allow for up to £50m of extra capital spending, though around £20m is expected.

From now on the Treasury will include government assets in its measure of debt, allowing additional investment in items such as schools, infrastructure and Labour projects like GB Energy and the National Wealth Fund.

The move is in part designed to quell rising uncertainty in UK government bond markets, which had been gathering momentum after years of weakness. Gilts plunged in 2022 when inflation surged in the wake of Russia’s invasion of Ukraine, and proposals for sudden, sweeping tax cuts in that year’s mini budget sent the markets into a tailspin.

That turbulence was the culmination of more than 10 years of poor performance. The yield on 10-year UK gilts was below 2.5% through 2014 to 2022, and earlier this decade the two-year gilt returned a negative yield.