Government borrowing costs eased following a turbulent day in Westminster at the beginning of the month, during which the chancellor, Rachel Reeves, became visibly emotional during Prime Minister’s Questions.
Chancellor reassures markets after emotional Commons appearance
The yield on UK 10-year bonds fell to 4.45% on Thursday, 3 July, down from 4.61% the day before. The pound also steadied at $1.3646, dipping following concerns about Reeves’s position. Although sterling didn’t fully recover, financial markets appeared to regain some confidence after Prime Minister Keir Starmer strongly supported the chancellor.
Analysts suggested the earlier rise in bond yields had been triggered by fears that Reeves might step down. Her potential departure raised concerns that the Government could lose credibility with investors and stray from its fiscal rules.
Markets prize political stability and fiscal discipline
Investors are believed to have responded positively to signs of unity between the chancellor and the Prime Minister. Starmer emphasised his alignment with Reeves, saying they were working “in lockstep” and that she was doing “an excellent job”.
The Treasury also reassured, saying Reeves had become upset during PMQs due to a personal matter. In later interviews, the chancellor confirmed this and declined to go into further detail.
While her emotional moment was widely shared, markets were more focused on the implications of a sudden change in leadership. Analysts noted that Reeves’s departure could have undermined the Government’s commitment to its fiscal rules, potentially leading to larger deficits and less investor confidence.
The reversal of plans to cut billions through welfare reform has already created an estimated £5 billion gap in Reeves’s financial strategy. As a result, she acknowledged that this would need to be accounted for in the Budget.
Fiscal rules under pressure as spending plans shift
The chancellor reiterated her commitment to her core fiscal rules, including that day-to-day Government spending should be covered by tax revenue, with borrowing reserved for investment only.
However, the loss of expected savings from welfare cuts leaves her with limited options: raise taxes, cut spending elsewhere, or issue more Government debt. Each carries its own political and economic risks.
Currency and bond market experts said the Government is now in a difficult position, with few easy decisions. However, Reeves is seen as a stabilising force, with credibility among investors thanks to her emphasis on fiscal discipline.
Some analysts suggested this episode shows how markets can influence political stability. One described it as a rare case of the financial sector boosting a politician’s career prospects by effectively supporting her continued leadership.
However, market volatility is likely to continue. With pressure mounting on public finances and fiscal choices limited, investors remain alert to any sign of instability or deviation from fiscal targets.
The impact of fluctuating bond yields could also be felt more widely. Higher yields feed into swap rates that lenders use to price fixed-rate mortgages. Although mortgage rates have remained relatively stable in recent months, they remain sensitive to changes in market conditions.
This episode follows a pattern seen during the Liz Truss premiership, when sudden Government policy and communication shifts directly affected borrowing costs and mortgage pricing.
In the short term, the Prime Minister’s public backing of Reeves has calmed markets, but the difficult fiscal choices ahead mean further scrutiny – and potential volatility – remain likely.
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