"LONDON, Jan 9 (Reuters) - Rachel Reeves is facing her first major test as Britain's finance minister after the government's borrowing costs climbed for a third day on Thursday and the pound's losses deepened, potentially forcing her to cut future spending.
The Treasury stated that it would maintain "an iron grip" on the public finances after a selloff in debt markets on Tuesday and Wednesday that pushed 30-year British government bonds to a 26-year high.
Gilt yields rose again on Thursday - albeit less sharply than over the previous two sessions - and the pound was on course for its biggest weekly drop in nearly two years.
The pound's decline and heavy government bond sales led to comparisons with the 2022 "mini-budget" crisis that resulted in former prime minister Liz Truss leaving Downing Street.
However, this week's market movements have been less severe, and there has been no sign of the stress on institutional investors that prompted the Bank of England to conduct emergency bond purchases in 2022.
Treasury minister Darren Jones informed parliament that the UK bond markets "continue to function in an orderly way. Underlying demand for UK debt remains strong."
PIMCO, a major global bond investor, expressed confidence in UK government bonds and attributed much of the trend to shifts in the U.S. bond market in anticipation of Donald Trump's presidency.
"UK-specific factors, such as the budget, have contributed to the rise, but the majority of the increase has been driven by rises in U.S. Treasury yields during the same period," noted PIMCO economist Peder Beck-Friis.
The new British government had unveiled plans for increased investment in public services and infrastructure to stimulate economic growth shortly before Trump's election victory on Nov. 5, which raised borrowing costs worldwide.
This shift in markets has heightened concerns among investors about the combination of high borrowing planned by Reeves and Prime Minister Keir Starmer, alongside the impact of their increased business taxes on an economy currently facing stagnation.
A survey of recruiters offered a gloomy outlook for December, with employment in the UK service sector and other retailers dwindling due to worries about weak consumer confidence.
Citi analysts observed that the market response to the budget had been gradual until now, but British bonds were now bearing the brunt of concerns regarding the extent of the government's borrowing plans, which could sustain inflationary pressures and delay the Bank of England's ability to swiftly lower interest rates to aid the economy.
"The market appears to be questioning the credibility of the fiscal plans, particularly with no significant fiscal event expected until autumn," they wrote in a client communication.
Some analysts argued that Britain's departure from the European Union had increased its vulnerability to financial market fluctuations.
"Brexit UK is vulnerable as a less core asset in global investor portfolios," said Krishna Guha and Marco Casiraghi of Evercore ISI in a report.
Britain is set to issue nearly 300 billion pounds ($368 billion) of government bonds in the upcoming fiscal year.
In her Oct. 30 budget, Reeves left herself little room for maneuver in achieving her goal of balancing public service spending with tax revenues by the end of the decade.
Economists believe that the surge in borrowing costs and economic stagnation since the July election indicate that Reeves is off track to meet the target, pressuring her to announce new measures to reassure investors of her ability to realign.
Reeves, who was slated to embark on an official visit to China on Thursday, disclosed no intentions to repeat substantial tax hikes after protests from business leaders following her April increase in social security contributions for employers, which had led to a slowdown in hiring plans.
She may opt for spending cuts in the upcoming years, but any move resembling the austerity measures criticized from previous Conservative governments would further damage the dwindling popularity of the current government.
Reeves will present a budget update to parliament on March 26, at which point official fiscal forecasters will assess her progress toward meeting set targets.
She has previously emphasized a preference for one major set of tax and spending announcements annually, decreasing the likelihood of significant measures being unveiled in March.
The Treasury announced that Reeves would deliver a speech in the following weeks on economic strategy and growth.
Former PIMCO CEO Mohamed El-Erian criticized Starmer and Reeves for swiftly embarking on unpopular measures such as cuts to winter fuel welfare for pensioners.
"This is an opportunity for the government to regain control of the narrative," he commented on BBC radio. "But it has to do so in a credible manner, focusing on measures particularly related to productivity and growth."
($1 = 0.8144 pounds)".