Markets calm after fears over Reeves’s future and welfare U-turn, as bond yields fall and investors respond to Prime Minister’s backing of fiscal discipline
UK borrowing costs have eased slightly following a sharp surge earlier this week, as financial markets appeared to respond positively to political reassurances from Prime Minister Sir Keir Starmer and continued confidence in Chancellor Rachel Reeves. After a volatile trading period marked by concern over Reeves’s emotional appearance in Parliament, the yield on 10-year government bonds dropped from 4.61% to 4.45% on Thursday. The pound also stabilised at $1.3646, though it failed to recover fully from the losses recorded the day before.
The market reaction followed speculation that Reeves might step down as chancellor, prompted by her visibly emotional state during Prime Minister’s Questions on Wednesday. The moment coincided with a government U-turn on welfare reform that left a near-£5 billion hole in the Treasury’s fiscal plans.
Investors, analysts suggest, are now factoring in political continuity and fiscal discipline as crucial elements in their decisions. Financial strategist Will Walker Arnott of Charles Stanley noted that the markets appeared to be acting as a stabilising force in this instance, implicitly backing Reeves’s position. He observed that financial institutions were wary of the impact a potential resignation might have on economic stewardship, stating that any departure by Reeves might lead to a weakening of fiscal controls and a rise in government deficits.
Market experts indicated that the recent dip in bond yields should be seen in context. Mohamed El-Erian, president of Queens’ College, Cambridge, and chief economic adviser at Allianz, warned that investor nerves may not settle quickly. He noted that while a measure of calm had returned, the risk premium introduced by this political uncertainty would likely persist, at least in the short term.
Bond yields play a key role in the wider economy, particularly through their effect on mortgage pricing. The yield on five-year bonds, in particular, helps shape swap rates that lenders use to determine the cost of fixed-rate mortgages. While mortgage rates have been relatively stable recently, any significant increase in bond yields could nudge them upwards, impacting homeowners and potential buyers alike. A similar trend was observed during the financial turmoil caused by Liz Truss’s mini-budget in 2022.
The political drama unfolded on Wednesday during PMQs when Reeves became tearful in the Commons chamber, triggering speculation about her future. Later clarifications from the Treasury attributed her reaction to a personal matter unrelated to her ministerial role. Reeves herself addressed the issue on Thursday, saying she had been upset due to private circumstances she was not willing to disclose.
The incident came just hours after the government announced a retreat from its planned welfare cuts, which were intended to generate savings of nearly £5 billion. That reversal has now raised new questions about how the chancellor intends to balance the books. Addressing these concerns, Reeves reaffirmed her commitment to the fiscal rules she introduced earlier in the year. She said that the cost of the policy change would be reflected in the next Budget but insisted that the government would not abandon its guiding principle that day-to-day spending should be covered by revenue rather than borrowing.
Analysts agree that Reeves faces a tough road ahead. Jane Foley, head of foreign exchange strategy at Rabobank, said that the “gutting” of the welfare reform package made the chancellor’s task more complicated. According to her assessment, Reeves is now left with few attractive options: raise taxes, cut expenditure in other areas, or increase government borrowing. Each choice brings with it political costs and practical challenges, contributing to a sense that the government is “boxed in”.
Nevertheless, Foley emphasised the importance of political consistency for market confidence. She pointed out that Reeves has earned credibility for her commitment to fiscal prudence and that her continued presence at the Treasury offers reassurance to investors. In that context, Starmer’s public endorsement of Reeves – describing her as “doing an excellent job” and stressing that they work “in lockstep” – appeared to play a significant role in steadying market sentiment.
The week’s events have revealed just how sensitive the markets remain to shifts in political stability and economic messaging. As the chancellor works to revise her Budget plans, the underlying challenge of maintaining economic discipline without derailing public support or investor confidence is likely to remain a central tension in the months ahead.
