This piece originally appeared in the Financial Times on 25 June 2026.
The UK will soon have a new prime minister, but not a new fiscal reality. Markets are bracing for a familiar autumn of tax and spending speculation ahead of the next Budget.
For now, investors have taken comfort from the commitment of leading contender Andy Burnham to the UK’s fiscal rules. But those rules are loose, open to interpretation, and do little to constrain near-term easing measures.
Bond markets remain on high alert and would react poorly to signs of fiscal slippage. When chancellor Rachel Reeves was visibly upset in parliament last summer, long-term borrowing costs jumped about 0.20 percentage points in a single afternoon, reflecting speculation about a change in personnel and fiscal strategy. In periods of global stress – most recently during the US-Iran war – gilts have tended to underperform peers.
Even routine monthly borrowing data has become a source of market volatility. This fragility reflects the fiscal position. Despite repeated talk of consolidation, the government still borrowed 4 to 5 per cent of GDP over the past year, alongside substantial refinancing needs.
That is not significantly different from peers such as the US or France, but the UK faces tighter constraints and is still rebuilding fiscal credibility after the market turmoil under the Liz Truss government.
Until the deficit falls further, the government is likely to remain sensitive to bond market sentiment. To restore credibility, the new government may need to learn from past mistakes and avoid focusing narrowly on selective parts of the deficit far into the future.
Former Office for Budget Responsibility chair Richard Hughes – who has been advising the Burnham team – told parliament in 2024 that successive governments have been “gaming” the fiscal rules, meeting “the letter but not the spirit of the rules”. Investors will continue to see through that.
The bond market worries less about the fine details of growth strategies or the precise mix – and even the overall level – of taxes and spending. Instead, it focuses on a simpler question: borrowing and issuance needs today and in the near term.
Consider three familiar temptations. The first is to borrow more to invest. This would be a risky strategy indeed. Bond markets do not meaningfully distinguish between types of spending: one pound of investment still requires one pound of gilt issuance. Higher investment may lift growth over time and improve debt dynamics, but the link is uncertain and markets will discount it until it is visible in hard data. In practice, more borrowing would push up yields and likely crowd out other investments.
Second, the government may again delay tightening by pushing consolidation into future years. But investors place little weight on plans three or four years ahead. Outcomes rarely match plans, often because assumptions prove too optimistic. Bond markets instead focus on the deficit today and next year and treat longer-term projections with scepticism.
Third, there will probably again be calls to redefine the target measure of debt, as Reeves did two years ago. But such change rarely persuades investors. The bond market compares debt across countries on a like-for-like basis – often focusing on gross debt and issuance – and forms its own judgment of debt sustainability.
A more credible strategy would focus on reducing the deficit over the next two years. Once it falls to about 3 per cent of GDP, debt should begin to stabilise. At that point, the bond market is likely to become less sensitive to fiscal and political headlines, as recent experience in Italy and Spain shows. More importantly, it would rebuild the capacity to run countercyclical fiscal policy in the next downturn.
For investors, gilt yields remain among the highest in developed markets, as they have been for most of the past two years. This largely reflects high shorter-dated yields: the Bank of England’s benchmark policy rate is high, and markets still expect some tightening ahead.
Those shorter-dated bonds look attractive to us. Unless the US-Iran conflict re-escalates and pushes energy prices higher, the BoE is unlikely to deliver the tightening priced in and may resume easing next year.
For longer-term gilts, however, where yields are more closely linked to fiscal credibility, there is some but not much risk premium priced. The curve of yields on short- to long-term gilts is not significantly steeper than peers. We think it makes sense to wait and see on the fiscal outlook, and judge the new government on its action, not forward-looking promises.