How markets reacted to the Budget

22 April 2009

UK government bonds fell sharply and the benchmark 10-year government bond yield shot up by nearly four basis points as chancellor Alistair Darling delivered his forecasts for public borrowing.

Markets had expected gilt issuance of £180 billion but Darling pencilled in a figure of £220 billion and market watchers say this could be as much as £260 billion over the next fiscal year.

For gilt investors buying today this translates to an annual yield of just 3.43% if investors hold a 10-year bond until redemption, compared with 4.8% a year ago.

Stock market sanguine

On the stockmarket, David Buik, spokesman for BGC Capital Partners, says insurance companies and asset managers were the biggest losers as traders reckoned high earners would be disincentivised to put money into pensions and other savings products.

The chancellor had announced the income tax relief on pension contributions would fall from 40%  for those earning more than £150,000, tapering to the basic 20% relief for those earning more than £180,000.

Valerie Smart, tax director, Scotland, at PricewaterhouseCoopers, says: "The cut in higher-rate tax relief on contributions to pension schemes may undermine incentives for private pension provisions. It also highlights the difference between those in public service and the private sector, given that private pension schemes have already been hit by the stockmarket collapse."

The wider stockmarket seemed to recover its poise after traders registered initial disappointment. At 2.30pm the FTSE 100 index of leading shares was down 0.5% but by the close it had rallied to 4,031, up 43.2 points, for a gain of 1.08%.   

Sterling falls

Reaction in the currency markets to the Budget was negative as traders digested the parlous state of public finances. Against the euro, sterling slipped nearly 2 cents to €1.114 and 2 1/4 cents against the dollar at $1.445.

"The figures for economic growth are optimistic at best, the chancellor has confirmed the alarming figures for borrowing. The tax increases and public spending cuts are insignificant against the size and scale of the government’s debt," says Alex Dunn, senior trader at Caxton FX.

"We see sterling falling in the short term against both the dollar and the euro, although against the latter, it will probably creep back as we approach the May meeting of the European Central Bank where further rate cuts are likely."

John Hardy, consultant foreign exchange strategist at Saxo Bank, says sterling’s recent rally is most definitely over as the government embarked on the "world’s most dramatic super-Keynesian experiment: massively expanding spending and the public balance sheet into the downturn in an effort to avoid a deflationary spiral".

He adds: "The chief problem for the UK is that it is launching this experiment from a profoundly weak starting point: the UK ran huge deficits when times were good and has terrible terms of trade to boot. So the only way it can finance new spending is by printing money, with the obvious end result of watering down its value."


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