The Healey borrowing plan to raise public debt by £9bn a year for infrastructure, housing and business investment has drawn a cautious response from fixed-income investors, who warn that gilt yields could drift higher as the Budget approaches.
Reports on Tuesday evening, first carried by The Times, said the Chancellor and Treasury ministers were drawing up proposals to channel borrowed funds through mayors for local investment. The spending would be structured to sit within Labour’s fiscal rules because assets acquired can offset the associated liabilities on the government’s balance sheet.
How the Fiscal Rules Create the Opening
The mechanism relies on a change made at the Autumn Budget 2024, when Chancellor Rachel Reeves switched the debt target from public sector net debt to public sector net financial liabilities (PSNFL), according to the Institute for Government. Under PSNFL, financial assets held by the state reduce the recorded debt figure, creating more room to borrow for investments that can be expected to generate a return.
The Economics Observatory notes that the UK has changed its fiscal targets more frequently than any other country, recording nine sets of rules since the 1990s, with the current targets described as loose by historical standards.
The headroom available under those rules is limited. Based on the OBR’s October 2024 forecast, PSNFL is set to peak at 84.2% of GDP in 2026/27 before easing to 83.4% by 2029/30. The government’s forecast headroom against the investment rule stands at £16.9bn, while the current budget surplus leaves only £9.9bn of breathing room for 2029/30, according to the Institute for Government.
Healey Borrowing Plan and the Gilt Market Warning
Richard Carter, head of fixed interest at Quilter, described an additional £9bn a year as ‘small fry in the grand scheme of things’, but cautioned that markets could still take a dim view of the direction of travel.
‘Borrowing dressed up in new clothes is still borrowing at the end of the day, and the UK’s precarious fiscal position is still somewhat at the mercy of the bond markets,’ Carter said. ‘Gilt yields are likely to continue to tread higher, and the debt servicing level will remain substantial.’
He added that markets may ‘shrug’ at the prospect of further borrowing, but said there was ‘an indication that spending remains the government’s preferred antidote to the growth malaise and it is that fact that markets may be less than impressed with’. Carter also flagged that there may be more ‘cost-effective ways’ to fund growth ambitions, including encouraging retail investors to buy gilts directly.
Gilt yields are already elevated. Thirty-year gilt yields have risen from 4.5% a year ago to 5.7% recently, their highest since 1998, while ten-year yields now stand close to 4.7%, according to the Institute for Fiscal Studies. The IFS also notes that the UK Debt Management Office has been rotating issuance toward shorter maturities: the weighted average maturity of primary gilt supply, above 20 years in 2016-17, is forecast to fall below 10 years in 2025-26.
The sensitivity of the public finances to yield movements is acute. NIESR calculates that a one percentage point improvement in the medium-term deficit-to-GDP ratio could lower gilt yields by 15 to 35 basis points and, with the UK debt stock approaching £3 trillion, even a 15 basis point reduction would reduce annual debt-interest spending by around £4.5bn over time, according to NIESR.
Debt interest payments are projected to total more than £110bn. The UK Debt Management Report 2025-26 puts central government debt interest (net of the Asset Purchase Facility) at £105bn for 2024-25, with that elevated level forecast to persist over the coming years due to higher rates.
Oliver Faizallah, head of fixed income at Raymond James, said there would be ‘a little bit of nervousness’ in the weeks leading up to the Budget. He predicted bond investors could demand higher interest payments on long-term debt as concerns over the government’s fiscal stance build.
Faizallah said the government would need to communicate clearly and ‘prove’ that any borrowed investment generates returns. ‘My first reaction isn’t “Okay, this is the first step towards fiscal irresponsibility”,’ he told City AM. ‘In order to satisfy the rules for the liability to be offset with an asset, it needs to be sort of proven that that asset is going to be additive to the UK. Then it just comes down to communication, really.’
The OBR has estimated that investment announced at the Autumn Budget 2024 will raise UK GDP by over 0.4% after ten years, and by 1.4% in the long run, according to the government’s response to the 2025 Fiscal Risks and Sustainability Report. Whether bond markets will wait that long for proof is the question hanging over the Budget.
