UK government borrowing costs spike amid divisions in Labour party

U.K. government borrowing costs spiked on Wednesday, amid question marks over the political future of Finance Minister Rachel Reeves and Britain’s fiscal credibility.

The yield on benchmark 10-year government bonds, known as gilts, was 22 basis points higher at 1:33 p.m. in London.

Meanwhile, the British pound shed 1% against the U.S. dollar to trade at around $1.362 by 2:06 p.m. in London.

Reeves’ political future was called into question after British Prime Minister Keir Starmer was asked in Parliament Wednesday whether she would still be in the role at the next election in 2029. Starmer deflected the question, instead pointing the finger at the leader of the opposition, Kemi Badenoch, questioning whether she would still be in office.

In a statement after the exchange in Parliament, the prime minister’s press secretary said Reeves “is going nowhere.”

“She has the Prime Minister’s full backing,” the press secretary said. “He has said it plenty of times, he doesn’t need to repeat it every time the Leader of the Opposition speculates about Labour politicians.”

Separately, a government spokesperson said Reeves, who looked visibly upset in parliament, said it was “a personal matter, which, — as you would expect – we are not going to get into.” They noted that Reeves would be working out of Downing Street this afternoon.

The Labour Party leadership has come under further pressure in the last 24 hours following a government U-turn over a controversial welfare reforms bill.

The bill passed in a vote Tuesday night but only after steep concessions to rebel lawmakers who opposed cuts to disability benefits. This effectively wiped out the £5 billion of savings initially envisaged as a result of the reforms — raising the prospect of further tax rises in the fall.

Reeves has come under sustained pressure since the Treasury’s “Autumn Budget” last fall when she announced strict rules that limited the government’s room for maneuver on spending and borrowing.

Robert Wood, chief U.K. economist at Pantheon Macroeconomics, told CNBC on Wednesday that the government’s concessions on welfare changes had “blown a hole in Ms. Reeves’ fiscal rules.”

“The market had been comfortable that Ms. Reeves would raise taxes enough to cover any shortfall, but any risk that the government borrows more instead will worry the market,” he said by email. “Questions about Ms. Reeves’ future raise risks that the government chooses to change the fiscal rules to borrow more rather than raise taxes.”

Reeves’ “fiscal rules” state that day-to-day government spending is funded by tax revenues and not by borrowing, and that public debt is falling as a share of economic output by 2029-30.

In spring, the Treasury had around £9.9 billion of limited fiscal “headroom” to meet its targets, but the economic and fiscal outlook had become more challenging with higher debt interest payments and weaker-than-expected tax receipts converging with lower economic growth forecasts.

The independent forecaster, the Office for Budget Responsibility (OBR), said in March that it expects the U.K. to record 1% growth in 2025 and 1.9% in 2026, potentially wiping out the government’s fiscal headroom.

After committing to a public spending splurge and hiking taxes on businesses to largely fund that, Reeves faced increasing pressure to plug the fiscal hole. To do she was faced with the options of cutting expenditures, raising taxes further or breaking her own borrowing rules — an outcome she had previously described repeatedly as “non-negotiable.”

Ashley Webb, a U.K. economist at Capital Economics, agreed that investors saw risks tied to the possibility of Reeves’s departure from Starmer’s cabinet.

“The rise in gilt yields this morning appears to be in response to the uncertainty over Reeves’ future as Chancellor,” she said. “It suggests that the markets are worried that the government’s future spending plans aren’t deliverable, and the government will end up spending and borrowing more.”

— CNBC’s Ganesh Rao contributed to this report.