LONDON, Jan 13 (Reuters) - Britain's finance minister Rachel Reeves and Prime Minister Keir Starmer are faced with the challenge of halting a market decline, yet the future movements of rising government borrowing costs and the declining pound are primarily outside of their grip.
The actions of Donald Trump and U.S. economic indicators are anticipated to exert a greater impact on determining whether the current UK market sell-off will be a passing setback or the commencement of a crisis for Starmer's administration, inaugurated last July.
During a visit to China last weekend, Reeves affirmed her unwavering commitment to rectify the public finances, impacted by escalating borrowing costs, stating, "we will take actions to ensure that we meet those fiscal rules."
Early on Monday, 30-year gilt yields surged to unprecedented post-1998 levels, with the pound dropping to its lowest point since November 2023.
When questioned about the market scenario, his team emphasized their resolute approach towards budget mending.
The government has criticized prior Conservative administrations for harming the economy and public finances following the turbulence of Brexit and the budgetary crisis during former Prime Minister Liz Truss's tenure in 2022.
Reeves, however, encounters limited avenues to shift market sentiment.
In case budget forecasters announce on March 26 that Reeves is deviating from her fiscal objectives, she might unveil forthcoming spending reductions to restore alignment.
Nonetheless, she already intends substantial spending restraints, and the notion of further cuts could provoke discontent among numerous members and supporters of the ruling center-left Labour Party.
The possibility of imposing additional taxes appears to be off the table due to firms recruiting employees following social security contribution hikes implemented by Reeves in her October budget.
Describing the situation as a "tough balancing act with no easy solutions," Hetal Mehta, St. James's Place head of economic research, remarked.
Reeves is slated to deliver a speech on economic growth in the upcoming weeks before outlining a detailed strategy in a two-year Spending Review expected in June.
Present measures aimed at reviving the economy are anticipated to yield tangible outcomes only in the 2030s.
Reeves' next comprehensive budget is scheduled for October or November, a period when the global economic landscape could be markedly altered.
Anticipations of additional tariffs on imports by U.S. President-elect Trump are likely to elevate U.S. inflation, leading investors to factor in solely one interest rate reduction by the U.S. Federal Reserve in 2025.
Given the nexus between British gilts and U.S. Treasuries, the likelihood of sharp decreases in yields appears low should Trump proceed with his tariff strategy.
Additionally, Britain's reliance on external entities, which former Bank of England Governor Mark Carney termed as "the kindness of strangers," to offset its substantial current account deficit ranks second within the Group of Seven after the United States.
Sanjay Raja, chief UK economist at Deutsche Bank, pointed out that many of these external entities are displaying higher volatility than in the past, with long-term bond holdings restricted to only 20% for pension and insurance funds, a significant drop from 75% two decades ago.
Meanwhile, foreign ownership has surged, primarily owing to the ascension of hedge funds.
"This, to a degree, clarifies why gilt market volatility has considerably surged in recent years, as heightened foreign ownership intensifies market oscillations," Raja outlined in a communication addressed to clients last Friday.
Also outside Reeves' sphere of influence are the interest rate deliberations of the Bank of England.
Presently, investors envisage approximately a 75% likelihood of two quarter-point BoE rate reductions in 2025, fewer than the nearly four anticipated from the European Central Bank.
The remarkably robust U.S. payrolls report released on Friday, suggesting minimal necessity for the Fed to hasten its rate reductions, resulted in a substantial depreciation of the pound by an entire U.S. cent.
Although some analysts posit that the BoE might interpret the uptick in market borrowing expenses as a hindrance to economic growth, bolstering the case for accelerated rate reductions, issues like inflation, wage agreements, and inflation anticipations continue to linger at uncomfortably high levels for the BoE.
Ben Zaranko, a senior research economist at the Institute for Fiscal Studies think tank, proposed that Reeves is unlikely to rush into short-term measures to reassure financial markets, which could indicate governmental panic.
"I don't think there's a pressing need for major actions to alter the sentiment," Zaranko asserted. "Yet, navigating through the spring and summer will surely pose challenges."
Mehta at St. James's Place emphasized that the primary enigma for Reeves revolves around the global economic outlook.
"Growth unquestionably holds the key in the short, medium, and long term," she declared. "That's the overarching concern. Fingers crossed for the global landscape to uplift the UK."