UK government borrowing costs have risen sharply amid speculation over Rachel Reeves’s position as chancellor, as City investors warned Labour’s welfare U-turn had blown a multibillion-pound hole in the public finances.
After Keir Starmer failed initially to give his full backing to a tearful chancellor at prime minister’s questions on Wednesday, the yield on 10-year UK government bonds, also known as gilts, had its biggest jump in a day since Liz Truss was in No 10, while the pound slumped.
The yield – in effect the interest rate – rose by as much as 0.2 percentage points to trade close to 4.7%, climbing by the most in one day since October 2022 when investor confidence in Britain remained shaken after Truss’s mini budget.
Highlighting investor unease over the government’s tax and spending plans, the pound also fell by more than 1% against the US dollar.
Downing Street later insisted that Reeves would remain in her post and had not offered her resignation after a major rebellion by Labour MPs forced the government to withdraw a planned £5.5bn cut to disability benefits.
However, investors warned the backtracking, which follows an earlier U-turn on winter-fuel payments for pensioners costing £1.25bn, put Reeves in danger of smashing her self-imposed fiscal rules without sweeping tax rises.
“A fiscal crisis now appears to be on the horizon unless tough decisions (such as tax rises) are enacted. Markets will be on high alert over the next months,” said Neil Mehta, a hedge fund manager at RBC BlueBay Asset Management.
“Last night’s parliamentary chaos underscores the government’s waning control over public spending. Reeves’s October budget has already increased 2025-26 public spending by nearly £100bn compared to the previous government’s plans, leading to higher borrowing and worsening inflation.”
Reeves has repeatedly pledged to stick to her “iron-clad” fiscal rules – which require day-to-day spending to be matched by receipts within five years – despite mounting spending pressures and rising debt interest costs.
Having committed against further large tax rises after the autumn budget, the chancellor turned to welfare savings in her spring statement to rebuild the headroom against her primary target to £9.9bn after a deterioration in the outlook for the government finances.
However, the threat of a backbench Labour rebellion and rise of Nigel Farage’s populist Reform UK in the opinion polls has led the government to reverse some of its planned cuts, leading to questions over Reeves’s authority.
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Investors warned that Starmer swapping his chancellor and adopting a looser approach to the public finances would probably be poorly received in financial markets, while economists said that tax rises at the autumn budget could be required to rebuild confidence.
Kathleen Brooks, research director at trading platform XTB, suggested the rise in bond yields was linked to speculation over Reeves’s position during PMQs. “The PM might be keeping his options open at this stage, but the chancellor is a strange choice to axe from a market perspective.”
Benjamin Caswell, a senior economist at the National Institute of Economic and Social Research, said the relatively limited headroom the chancellor had left against her fiscal rules had created problems as the economic outlook turned.
“Once you’ve established the rule the most important thing is to set yourself credibility against it. If you’re having to change course and tinker and make piecemeal ad-hoc adjustments every six months that doesn’t convey credibility,” he said.
“There should be serious consideration of raising one of the big three taxes [VAT, income tax, and national insurance] in the autumn budget.”