Major bond investors are asking Reeves to build a bigger financial buffer

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Two of the world’s biggest bond investors have urged Rachel Reeves to build a bigger buffer into the UK’s public finances in her November Budget to avoid years of uncertainty over tax and spending decisions.

Pimco and BlackRock said the finance minister needed to move beyond the slim £9.9bn margin she left against the main borrowing base in the last two financial events, which would force her to make tax rises or tougher spending cuts.

“If you have to drive from here to somewhere 50 miles away, you don’t have 50 miles worth of gas,” said Andrew Bowles, chief investment officer at Pimco Global Fixed Income. “We think it would make sense to have more of a buffer.”

Simon Blundell, co-head of active European fixed income at investment giant BlackRock, added that the government needs to “create a certain level of stability and certainty going forward.”

“Something has to give, whether it’s on the tax side or more upside or changing the fiscal rules,” Blundell said.

Building further upside would be a “best case scenario for the gold market.”

The issue is under discussion at the Treasury, as Reeves looks to plug the huge fiscal gap that has opened up despite her raising £40bn in taxes in her first budget last year.

Reeves said last week she might Eliminate the Office of Budget Responsibility Spring forecast, which means the financial watchdog will make just one ruling a year on whether it is on track to meet its financial rules.

One option under consideration is to replace the spring forecast with the Office for Budget Responsibility’s current long-term fiscal sustainability report, according to people familiar with the discussions. The report, published in July this year, looks at threats to public finances but does not assess compliance with fiscal rules.

“There is justification for building more space,” one government official said. “Clearly this would help reassure markets as we move to one forecast each year. But the obvious downside is that it would mean more tax increases or spending cuts to cover its costs.”

Treasury Department veterans wonder whether Reeves is willing to take a major political hit by raising taxes to create a larger fiscal reserve. “She may end up building a war chest for her successor,” said one former Conservative official.

Government borrowing rates have risen globally in recent months, but the UK has the highest rates among the G7, partly due to higher inflation than peer countries.

Ten-year bond yields The most closely watched measure of government borrowing costs reached a 16-year high in January at 4.93 per cent, but has since fallen to nearly 4.72 per cent.

Other major bond markets, such as France and Japan, have seen larger increases in their borrowing costs this year.

Analysts widely expect the Chancellor to announce big tax rises next month, as productivity cuts from the Office for Budget Responsibility open a new hole in the public finances.

The Treasury has now received its first special forecasts from the Office for Budget Responsibility and is discussing the shape and size of the tax increases. Officials are also looking for public sector savings as they try to reduce borrowing, according to people familiar with the process.

Analysts widely expect Reeves to face a financial gap of between £20bn and £30bn due to an expected reduction in the productivity of the Office for Budget Responsibility.

Michael Saunders, a senior adviser at Oxford Economics, said building on greater freedom would increase the credibility of fiscal plans, which could “produce significant rewards from lower government bond yields.”

The problem with raising taxes more steeply to build a larger reserve is that the measures could hurt growth and spark a backlash, after Reeves pledged last year not to raise taxes again after the £40bn October 2024 budget.

Public anger will be particularly acute if Reeves breaches Labor pledges not to increase income tax, VAT or National Insurance. It already raised employer national insurance in last October’s Budget.

Reeves’ main fiscal rule requires her to achieve a surplus in the current budget – which excludes investment – by 2029-2030.

Saunders said Reeves could be looking at £6bn in savings by identifying spending cuts in 2029-2030. But investors may wonder whether such cuts will happen. The next general elections must be held by August 2029.

Saunders added that one positive for the Chancellor is higher-than-expected wage growth and inflation, which could bring in an additional £9 billion in tax revenue in 2029-30.

A Treasury spokesman said: “The Chancellor’s non-negotiable fiscal rules help keep interest rates low while prioritizing investment to support long-term growth.”

“This is the responsible choice – reducing our borrowing levels in the years ahead so we can spend more on our public services, more on working priorities and less debt servicing.”