Investors pile into UK bonds and sterling after budget

By Amanda Cooper

LONDON (Reuters) -Investors ‌piled into long-dated UK bonds on Wednesday, pushing yields down by the most since April, and boosted the pound after UK ‍finance minister ‌Rachel Reeves' budget helped alleviate some concern about Britain's long-term finances.

Reeves delivered a budget that will take more tax from workers, people saving ⁠for a pension and from investors to give herself more room ‌for meeting her borrowing targets - a central concern for investors.

In a release first reported by Reuters, the Office for Budget Responsibility (OBR) said the headroom - the amount of extra spending or tax cuts possible for the government while staying within its budget rules - now stood at almost 22 billion pounds ($28.9 billion) in five years' time.

A Reuters ⁠poll had expected Reeves to leave herself just under 17 billion pounds of headroom, up from just under 10 billion.

Thirty-year gilt yields were down 11 basis points in late trading ​at 5.215%, set for their largest one-day drop since mid-April, as prices surged.

The rally ‌in bond prices gathered pace over the afternoon, as the amount ⁠of new longer-dated debt the government intends to sell was expected to decline, after the Debt Management Office cancelled several planned auctions, analysts said.

'COULD HAVE BEEN A LOT WORSE'

Sterling rose 0.5% to $1.32295, bringing gains over the last week to 1.325%, the most since August.

    "It could ​have been a lot worse and that's what the market was fearing," Rory McPherson, chief investment officer at Wren Sterling.

"Looking at the key market indicators, it has been taken positively. Stocks sold off and are now rallying, bond yields have come down, which means we could get a rate cut, and inflation swap markets and the currency are also stable," he said. 

Several banks changed their trading recommendations for sterling and gilts ​based on the ‍budget, with Nomura closing a position that ​favoured the euro against the pound and Mizuho analysts saying they were bullish towards UK gilts relative to U.S. Treasuries.

JPMORGAN'S DIMON SAYS 'SHOULD BE WELCOMED BY MARKETS'

JPMorgan chairman and chief executive Jamie Dimon said Reeves' focus on measures to foster growth in her budget was the only way to "lift up everyone".

The rally in gilt prices, which pushed down yields, spread to other maturities. Five-year yields were down 5.7 bps on the day at 3.878%, while two-year yields fell 4 bps to 3.726%. 

Expectations for what the Bank of England might do with interest rates when it sets monetary policy next ⁠month remained largely unchanged relative to where they were prior to Reeves' budget announcement.

Investors welcomed Reeves' budget for the most part, but some economists expressed caution over the hefty tax hikes and how those ​might impact growth in the longer run.

"My concerns are that the headroom - although it looks bigger, 22 billion pounds versus the current spending of 9.9 billion pounds - when I look at the composition a lot of it is backloaded," Kallum Pickering, chief economist at Peel Hunt, said. 

"You go pretty aggressive from 2026 onwards into a current surplus, which means the market is being asked ‌to believe the OBR forecast which is chronically optimistic, which is why I think the market is a bit concerned."

UK shares rallied, pushing the FTSE 100 up nearly 1% on the day.

(Reporting by Amanda Cooper, Dhara Ranasinghe, Lucy Raitano and Yoruk Bahceli; Editing by Dhara Ranasinghe and Ros Russell)