British government bonds, stocks and sterling tumble as budget rumours swirl

By Alun John and Dhara Ranasinghe

LONDON, Nov 14 (Reuters) - British markets were whipped around on Friday, with sterling, government bonds and stocks suffering steep losses as speculation swirled around the UK government's highly-anticipated November 26 budget.

Finance minister Rachel Reeves has no plans to raise income tax rates in the budget, a government source said on Friday, alarming investors who had been anticipating a rise to help fill an expected fiscal shortfall.

Markets sold off sharply after the Financial Times first reported the news, and only slightly recovered after other outlets, including Reuters, cited sources saying improved fiscal forecasts were a factor in the change.

Still, British assets remained under pressure, highlighting the renewed uncertainty.

The 10-year government bond, or gilt, yield jumped 13 basis points to 4.58%, its highest in a month, and was set for its biggest one-day rise since July when concern around Reeves' position as finance minister briefly roiled markets.

Gilts underperformed U.S. and German peers GB10YT=RR, DE10YT=RR, US10YT=RR. Bond yields move inversely to prices.

Sterling fell 0.4% to $1.312 and tumbled against the euro, which hit its strongest levels against the pound since April 2023 at around 88.64 pence GBP=, EURGBP=.

"Clearly, the market had been hoping the government would take steps to deal with its fiscal shortfall and that would mean a rise in income tax," Jeremy Stretch, head of G10 FX Strategy at CIBC Markets, said.

He said the media reports had shaken that view, "so, what we're seeing is a lack of confidence from markets and especially the bond markets."

British government bonds, until Friday, had outperformed peers helped both by traders' bets that weak economic data and cooler inflation would help the Bank of England cut rates more quickly, and what they had thought were Reeves' plans to raise income tax.

Ten-year yields are still down around 20 basis points from the start of September, but up more than 10 bps from their mid-October lows.

"The market was feeling pretty smug that the bond market had sort of won, that she (Reeves) was so frightened of upsetting the gilt market and creating another 'Liz Truss moment' that she would hike taxes, and they liked the cleanness of that proposal," Jane Foley, head of FX strategy at Rabobank, said.

Truss, a former prime minister, left office after just seven weeks in 2022 when bond prices slid in reaction to her budget plans.

Foley said Reeves had other options such as property taxes, or moves on pensions, but "these are not as clean, and may have bigger secondary implications, may alienate the business community".

Markets were also concerned that Reeves may have to borrow more, she added.

BUDGET MAYHEM

Reeves is expected to need to raise tens of billions of pounds to stay on track for her fiscal targets, and her recent comment that "we will all have to contribute" was seen as paving the way for the government to break its main election pledge and hike income tax rates.

UK Prime Minister Keir Starmer's authority within his own ruling party has also come under strain.

Britain's blue-chip FTSE index shed 1.3% .FTSE, with bank stocks Barclays BARC.L, Lloyds LLOY.L and Natwest NWG.L down around 3% each.

Traders said lenders were hurt by fears that if Reeves did not raise income tax, higher taxes on banks may be needed to fill a fiscal hole.

It is typical for higher bond yields to send a country's currency higher. But on several occasions this year, worries about Britain's fiscal position have seen government bonds and sterling sell off together.

This, Foley said, was partly because of the high number of gilts held by overseas investors.

Traders were also assessing the implications for the Bank of England, widely expected to cut rates in December.

A less fiscally tight budget or one that contributes to higher inflation - something Reeves has said she wishes to avoid - could complicate that picture.

"If the market does eventually believe the growth forecasts that are coming through, which are a little bit more optimistic than consensus, they will settle down," Seema Shah, chief global strategist, Principal Global Investors, said.

"But at the moment, I would expect the stress to persist for a bit longer."