What's an investor in Britain's market to do if the finance minister cries?

Classical economic theory is based on rational consumer behavior and does not suggest that emotions are sometimes a key driver of some decisions and events. But British Chancellor of the Exchequer Rachel Reeves' tears in the House of Commons last week precisely caused a nervous reaction from investors, who staged a £3 billion sell-off. Independent analyst Mikhail Zavaraev discusses what, setting aside emotions, an investor should pay attention to on the British market in the near future.

On July 2, British Prime Minister Keir Starmer defended welfare reform at a debate in the House of Commons. The government planned to significantly cut welfare payments for people with disabilities from 2026, which would save 5 billion pounds a year until 2030. Annual spending on disability and incapacity benefits in Britain already exceeds its defense budget and will exceed £100 billion by 2030, up from the current £65 billion. 

During the debate over reform, Rachel Reeves, who heads the British Treasury, i.e., the Treasury Department, cried foul. Opposition leader Kemi Badenoch asked Starmer if Reeves would remain in her post until the next election, to which he replied that she herself - Badenoch - would "definitely" no longer hold her post, but said nothing about Reeves. 

The minister's reaction, which was obviously upset, was broadcast live. Investors responded nervously: on July 2, the yield on 30-year government bonds (gilts) soared 20 basis points over the course of the day to above the 5.4% level. Reeves's tears triggered a £3 billion sell-off in the British market, according to The Telegraph. The next day, Starmer said Ms. Reeves would remain in her post and he was fully on her side (the prime minister even hugged her at a public event). And Reeves herself said she was crying because of personal issues. After that, the markets recovered some of the losses. 

The logic of investors is simple: Rachel Reeves is associated with fiscal discipline, which is so much needed now not only in the UK, but also in many other developed countries. Accordingly, replacing her with someone else could lead to the state budget deficit exceeding its targets;

Especially since many people still have fresh memories of the Liz Truss administration, which was famous not only for its shortest term as prime minister, but also for its economic policies, also called "Trasonomics". It involved, among other things, tax cuts for high earners and corporations. These proposals also led to a massive sell-off in Britain's financial market in the fall of 2022 because, along with the tax cut plan, Truss did not present sufficient sources of funding for her reform. While comparisons between the two stories are hardly entirely correct, the fact remains that Britain is still living beyond its means, and there are few completely painless ways out of the situation.

The ratio of net government debt to GDP (excluding state banks) in Britain has already exceeded 96%, the highest level in more than 60 years. At the beginning of the century, the ratio was less than 30%.

The last time public sector net borrowing was negative was more than 20 years ago. In recent years, the figure has been hovering around 5% of GDP, and in the first year of the COVID pandemic, the borrowing level was almost 15%. Since the global financial crisis, net government borrowing has only been below 3% of GDP four times. 

In turn, real GDP growth has averaged just 1.5% per annum since the same crisis, and this is unlikely to improve any time soon. In the first quarter of 2025, the UK economy was only 4.2% above its pre-pandemic level (fourth quarter 2019). Among the G7 countries, only Japan and Germany are doing worse.

On the other hand, GDP growth forecasts are improving, albeit slightly. While in April the IMF thought the U.K. economy would grow by 1.1% this year, in May the fund improved its forecast to 1.2%. But medium-term growth will still be modest compared to before the global financial crisis - at 1.4% - due to low labor productivity, the IMF said.

Not surprisingly, with such inputs, budget discipline is one of the few effective ways to somehow limit further growth of the national debt;

However, the situation with this has remained difficult in recent years, although the goals are quite ambitious. In fiscal year 2025, the budget deficit exceeds 5% of GDP. The OBR (Office for Budget Responsibility of the United Kingdom) predicts that in 4-5 years this figure should reduce to around 2%, a level that has only been achieved once in the last 25 years. 

The key driver of the budget deficit reduction should be the growth of state revenues - two thirds of it should be reduced by increasing taxes. The remaining part of the reduction is planned to be achieved by reducing expenditures;

But, as usual, everything looks quite smooth on paper, but in practice there may be problems with the implementation of these plans;

There are some questions about potential cuts to public spending. In particular, last week, Keir Starmer was able to "push through" in Parliament a project to cut social welfare spending. But only after agreeing to reduce and delay those cuts, which drew criticism, including from within his own party. The savings on incapacity benefit payments will now only amount to about 2 billion pounds. The opposition has already said that the cabinet will have to either raise taxes or cut public spending in other areas to close the budget hole.

At the very least, both tax increases and decreases in government spending may have a negative impact on GDP growth rates. As a result, the final increase in tax revenues may not be as significant as currently assumed;

For example, according to prediction Henley & Partners, already this year the UK will be at the forefront of the outflow of the super-rich: 16,500 millionaires will leave the country in 2025. This is more than twice as many as China, which for the past 10 years has led the way in the number of millionaire taxpayers lost to the country. 

Given the collapse of Starmer's own ratings over the past year, including through chaotic cuts to benefits, and the fact that the UK has already changed six governments in the past 10 years, there is reason to believe that any serious reduction in spending will be difficult;

But the main problem is that the next change of the Cabinet of Ministers (if it happens) will definitely not be able to solve this problem. It is not about personalities, but about the current economic situation. At the very least, politics and economics are clearly at odds here. Already this fall, during the discussion of the annual budget, we will be able to see how acute they are;

It is unlikely that the coming months will be calm for the British market, especially for bonds and the national currency.

The situation is further complicated by the fact that rates in the UK economy are still quite high, also due to persistent inflation risks. 

Although the Bank of England lowered the rate by 25 basis points in May, it remains at 4.25%. And while current expectations are that the British regulator will continue to cut the key rate in the coming quarters and it will reach 3.5% in the middle of next year, long bond yields remain very high. The current 10-year bond yield is above 4.6% - it remains near the high of the past 18 years. 

As a result of rising interest rates in recent years, debt servicing costs have also risen significantly. The OBR previously estimated that in FY 2025, the UK's debt interest costs will exceed £100 billion - that's 8.2% of total government spending or 3.7% of GDP. The current budget deficit (for the first two months of the 2026 fiscal year) was 27.4 billion pounds, 1% higher than expected. By comparison, Britain spent an average of 1.9% of GDP on debt servicing in the 10 years before the pandemic. 

And while these numbers don't look catastrophic at first glance, Britain continues to be one of the leaders among developed countries in spending on servicing government debt. Obviously, this leadership does not make voters very happy. 

Rating agencies, while continuing to give the UK relatively high ratings with a stable outlook, note that high debt and little fiscal policy space are a serious problem for the country, especially in the event of exogenous shocks. For example, Fitch notes that the UK's debt/GDP ratio is about twice as high as the average for other comparably rated countries.

Nevertheless, it is obvious that the nerves of investors in the British market are strained, which is the reason for the rapid collapses and sell-offs we saw last week. After all, the reason, in fact, was not the most serious for the market;

If a hint that a finance minister seeking fiscal discipline might be fired was enough to "move" the 30-year bond market by 20 basis points in a single day, then how were markets to be affected in the event of more serious shocks.

On the other hand, the expected increase in volatility in the coming months, among other things, suggests the emergence of investment opportunities. In particular, if yields fall to 4.45% on 10-year gilts, it makes sense to consider selling them, while if yields rise to 4.8%, on the contrary, consider buying bonds.

This article was AI-translated and verified by a human editor