How the financial markets reacted to the UK budget (and why they matter)

Rachel Reeves’s second budget landed in an unusual fashion. Before she delivered it, most of the key details had already been revealed accidentally by the Office for Budget Responsibility.

This meant many observers – including the financial markets – had an unprecedented preview of the chancellor’s announcement^[1]. But what are these markets that governments are so mindful of when they come up with economic policy, and why does it matter what they think or do?

Generally, “the markets” refers to a broad set of investors who buy, sell and set the price of financial assets such as shares, bonds and currencies.

Key among them are the buyers of UK government bonds (commonly known as “gilts”), which is a form of government debt. Investors effectively lend money to the government, which pays it back with interest.

Buyers of gilts include pension funds, insurance companies, asset managers, banks and overseas investors. Their willingness to hold UK debt determines how much it costs the government to borrow (the more willing the investors, the cheaper it is for the government).

Alongside them are currency traders, who buy and sell the pound based on how they view the UK’s economic outlook. Their decisions feed directly into the value of sterling. A third group are equity investors, who assess how tax and spending changes will influence the profitability of companies listed on the stock market.

These different groups don’t coordinate with one another, but together they form the landscape described as “the markets”.

Rachel Reeves will have been relieved that the fairly muted reaction from all of the markets, despite the unprecedented preview^[2], was striking mainly for its lack of drama. Traders still watched the chancellor’s speech line by line, but because so much of the package had been briefed in advance, there was very little for investors to reassess.

The £26 billion increase in taxes^[3] helped calm the markets’ fears of reckless fiscal giveaways. As a result, the bond markets barely moved.

Currency traders responded in much the same way. Growth estimates have been downgraded^[4] but with no unexpected measures, the pound held steady against other major currencies. This signalled that investors saw nothing in the announcement to shift the UK’s inflation outlook or expectations over interest rates.

Equity markets too were largely unchanged, as the measures affecting specific sectors were already anticipated and mostly priced in. Overall, investors appeared to take the view that the budget simply confirmed what they already knew.

Even a muted reaction carries meaning for the wider economy. Small declines in gilt yields (the interest paid to investors) still help lower government borrowing costs, easing the pressure on the public finances at the margin. And because gilt yields serve as a benchmark for mortgages and business loans, even modest downward movements can help gently soften borrowing conditions across the economy.

A stable pound also matters. When exchange rates remain steady, the cost of imports becomes more predictable, which supports efforts to control inflation. It also reinforces the sense that markets see no new risks on the horizon, which is a form of reassurance in itself.

Behind these movements lies a broader judgement about credibility. Markets constantly assess whether the government’s plans are coherent, deliverable and consistent with long-term economic goals.

They do not demand austerity, but they do look for fiscal plans that add up and do not introduce unnecessary risk. The absence of significant volatility after Reeves’ announcement suggests that investors concluded the budget was neither a breakthrough nor a cause for concern. It simply met expectations.

In financial markets, credibility sits at the centre of every reaction. The muted response implies that investors were broadly satisfied that the government’s plans were realistic and contained no unwelcome surprises.

But credibility is not something won permanently. It can take years to build in the eyes of bond markets, yet it can evaporate in a single misstep. The UK still has a long road back to genuine fiscal sustainability – but for now at least, the financial markets seem content with what they heard.

References

1. ^{^} chancellor’s announcement (theconversation.com)
2. ^{^} unprecedented preview (www.bbc.co.uk)
3. ^{^} £26 billion increase in taxes (www.ft.com)
4. ^{^} have been downgraded (www.bbc.co.uk)
5. ^{^} Fred Duval/Shutterstock (www.shutterstock.com)