Sterling hovered near its highest levels in three years against the dollar on Wednesday, while UK government borrowing costs climbed, as Finance Minister Rachel Reeves unveiled a multi-year
spending plan amid mounting pressure to support a slowing economy.
Reeves' review outlined how over £2 trillion ($2.7 trillion) in public funds will be allocated, with government departmental budgets set to increase by 2.3% annually in real terms.
The yield on the UK’s 10-year gilt rose by up to 7 basis points ahead of the announcement, reflecting investor nerves. However, it eased slightly following softer-than-expected U.S. inflation data, which sparked a global rally in government bonds. The yield ultimately settled 2 bps higher at 4.56%, still lagging behind other major European markets where yields slipped modestly.
Sterling gained 0.2% to trade at $1.353, bolstered by the weaker U.S. dollar, though it remained nearly flat against the euro at 84.77 pence.
Commenting on the review, Investec’s chief economist Philip Shaw said: “The spending review was essentially about dividing up a fixed budget—more about slicing the cake than baking a bigger one.”
Fiscal constraints and future tax risks
Market analysts emphasized that the review signaled ongoing fiscal constraints, raising the possibility of tax increases later in the year.
"If the chancellor does raise taxes, it could suppress demand—but that might be offset by increased government spending, leaving the net effect unclear," Shaw added.
Investors now face a complex outlook: a weakening economy that may lead to quicker interest rate cuts, alongside high government spending and debt levels that could keep upward pressure on borrowing costs.
“It’s a tough balancing act,” said Jason Da Silva, director of global investment strategy at Arbuthnot Latham. “Sluggish economic growth usually pushes bond yields down, but rising debt and fiscal spending are keeping them elevated.”
The UK’s fiscal fragility has been a persistent concern for investors, with Britain's 30-year bond yields still the highest among the G7 countries.
Markets react as sterling, FTSE rally
Despite fiscal anxieties, sterling and UK equities have held firm, benefiting in part from investor caution around U.S. assets amid uncertainty over President Donald Trump’s tariff policies and the broader U.S. economic outlook.
The FTSE 100 index is on the verge of hitting a new record high, gaining nearly 9% in 2025 so far. In comparison, the S&P 500 has climbed around 3%.
Sterling has also seen robust performance this year, up nearly 8% against the dollar.
Looking ahead, the Bank of England is expected to hold interest rates steady at its meeting next week. However, recent soft labor market data has increased speculation that rate cuts could arrive before the end of the year.