How Reeves could ‘trigger’ bond market fright and collapse UK economy
Poor decisions made by Rachel Reeves at the next Budget could send the UK economy into a crisis if her announcements trigger a collapse in bond markets’ confidence, according to a scenario played out by analysts at Oxford Economics.
Rachel Reeves has pledged to drive growth in the UK and lower the cost of living for Brits across the country at the Budget despite projections taxes could rise by more than £30bn.
But in a scenario where markets losing confidence led to bond yields rocketing and the pound plummeting against the US dollar, the UK economy could be crushed by a 0.6 percentage point hit to GDP.
Fresh research published by the economics consultancy is set to intensify pressure on Reeves given her decisions could hit growth and inflation.
Why Rachel Reeves could spook bond markets
Analysts at the economics consultancy said the UK faced greater risks given traders were currently giving the government “the benefit of the doubt”.
Its new report said that although the UK had a lower level of gross government debt than most countries, it did not have the same “structural benefits” as other economies.
Japan, for example, had strong demand from savers for its government debt while the US enjoyed being the world’s reserve currency, the report said, meaning more of the UK’s debt was held by foreign investors.
In turn, the UK was more exposed to “swings in market sentiment”. Next month’s Budget was the “obvious trigger” for a loss of confidence in the UK, according to Oxford Economics – should its contents be poorly received.
The report set out a number of ways Reeves could spook the bond markets and give rise to an economic crisis.
It said that while Reeves is expected to stick to her rules to keep day-to-day government spending in balance in a three-year forecast period and to reduce a form of government debt in the same time frame, she could make tax choices that put public finances on an unstable footing.
The Chancellor is widely expected to have to plug a fiscal hole worth around £30bn at the Budget due to lower productivity forecasts, higher government debt payments caused by rising gilt yields and costs from U-turns on welfare reforms.
A decision to drive up government revenue from “a series of smaller taxes” could leave markets on edge given behavioural responses “may prove greater than expected” and lobbying efforts from affected groups might further depress Labour’s poll ratings.
“Historically, revenue-based consolidations have a low success rate,” said Andrew Goodwin, chief economist at Oxford Economics.
“Trying to raise large amounts of extra revenue from smaller taxes may also undermine the credibility of the government’s plan.”
Moves to leave a smaller headroom than £9.9bn – already the third smallest fiscal buffer left by any Chancellor in the last 15 years – and tweaks fiscal rules by reducing the number of times the Office for Budget Responsibility (OBR) publishes forecasts in a one-year period could also frighten bond traders if the move is interpreted as a signal of the government’s “position of weakness”.
Should markets lose faith and sterling depreciates, the UK could struggle to combat high inflation.
Under this scenario, Oxford Economics believes the Bank of England would keep interest rates at four per cent for the rest of 2026 and prevent borrowing costs from dropping.
In this case, GDP growth would also be 0.6 percentage points below Oxford Economics forecasts by the end of 2027.
Reeves’ poor decision-making would force Labour to “belatedly change” its course on the UK economy and instead cut spending to restore market confidence, with all the political chaos such a move would entail.