Gilts under pressure as investors brace for higher spending under new PM

UK government bonds, known as gilts, are experiencing downward pressure as investors are preparing for potentially higher government spending under the new Prime Minister, Andy Burnham. This sentiment has led to a weakening of the pound and a rise in gilt yields, reflecting increased borrowing costs for the UK government. For example, ten-year gilt yields rose by eight basis points to close at 5.03%, while 30-year yields increased by nine basis points to 5.75%, reaching their highest level since May 20.

Burnham's recent comments about seeking "flexibility" within existing fiscal rules have contributed to investor unease. This comes at a time when Britain's borrowing costs are already the highest among Group-of-10 nations, and public debt is close to 100% of the gross domestic product. The bond market's reaction highlights its "hyper-reactive" nature, with investors keenly watching for any cues on public spending intentions, funding mechanisms, and policy shifts.

The market's sensitivity is partially due to recent economic data, which showed a significant overshoot in public borrowing. May's public sector net borrowing (excluding banks) came in at £23.29 billion, £5.6 billion higher than the Office for Budget Responsibility's (OBR) forecast and £4.4 billion above the Bloomberg consensus. This marks the second consecutive month of overshooting OBR forecasts and represents the highest May borrowing figure since 2020. Year-to-date borrowing is now £7.72 billion above the OBR's forecast.

The expenditure-driven nature of this overshoot, coupled with less favorable central government receipts, is concerning investors. Interest payments overshot by £2.37 billion, net social benefits by £1.11 billion, and consumption expenditure by £1.21 billion. The overall fiscal picture suggests elevated spending, which is driving investor caution regarding the UK's financial stability under the new administration. The FTSE 100 remained largely flat as traders awaited further details on Burnham's economic policies and cabinet appointments.