By Lucy Raitano and Naomi Rovnick
LONDON (Reuters) -Britain’s borrowing costs rose and sterling stayed close to recent three-year peaks against the dollar on Wednesday, as a multi-year spending review underlined fiscal challenges even as pressure mounts to boost the economy.
British finance minister Rachel Reeves delivered a spending review dividing up more than 2 trillion pounds ($2.7 trillion) of public spending, with the government’s departmental budgets to grow by 2.3% a year in real terms.
Britain’s 10-year gilt yield was up as much as 7 basis points (bps), rising ahead of the review, but fell back after weaker-than-expected U.S. inflation numbers prompted a broad rally in government bond markets.
It was last up 2 bps to 4.56%, still underperforming its peers. Bond yields across other big European government markets were slightly lower on the day.
Sterling was last up 0.2% at $1.353 as the dollar fell against major currencies following the U.S. data.
Ahead of that report, sterling had showed a muted reaction to the spending review and was just a touch softer against the euro at 84.77 pence.
“The spending review itself was about the allocation of an existing spending total, in other words how you cut the cake,” said Investec chief economist Philip Shaw.
CONSTRAINED
Analysts said the main takeaway for markets from Reeves’ speech was confirmation that the UK remains constrained in spending, raising the prospect of tax increases later this year.
“Were the chancellor to raise taxes, then that could weigh on demand. But presumably that would be offset by an increase in spending, so the picture really isn’t very clear,” said Shaw.
Investors are left grappling with a darkening economic outlook with the potential for more rapid rate cuts, implying downward pressure on borrowing costs and fiscal worries that are putting upward pressure on yields.
“It is very difficult to manage this balance. Because typically what happens is when you have economic growth which is a bit soggy, that tends to bring down bond yields,” said Jason Da Silva, director of global investment strategy at Arbuthnot Latham.
“But the increasing fiscal spend and government debt being extremely high is a headwind for (UK government) bonds,” he added.
Concerns about the UK’s weak fiscal position have weighed on UK assets in recent months, and Britain’s 30-year bonds remain the highest in the Group of Seven industrialised economies.
Sterling and UK equities meanwhile have been cushioned by bearishness towards U.S. assets given President Donald Trump’s tariff policy and a murky economic outlook, prompting global investors to diversify away from U.S. markets.