Gilt relief masks fresh risks for mortgages
The gilt market’s initial response to Rachel Reeves’ Autumn Budget looked reassuring for anyone watching UK borrowing costs. Long‑dated gilts rallied, 30‑year yields dropped by around 10–11 basis points, and sterling firmed as investors welcomed a Budget that appeared to prioritise fiscal caution over eye‑catching giveaways.
But beneath the surface, some economists think the story for UK assets – and by extension for the housing market and mortgages – is more complicated, and potentially much less friendly.
Oxford Economics’ chief UK economist Andrew Goodwin argues that while markets gained from the Budget on day one, the medium‑term politics and arithmetic simply don’t add up.
“Though the initial reaction was positive, we think markets will look increasingly critically on the Budget,” he says. “The idea there will be a large tightening of policy in the year of the next election doesn’t look credible. The focus on tax rises is another problem – these are more prone to failure than spending cuts, and that risk looks even higher given the Chancellor’s decision to try to raise money from a variety of smaller revenue streams.
“We think the most likely outcome is that term premium grinds upwards, causing longer-dated yields to rise, with sterling also weakening. But there’s a high risk that an event causes a more abrupt loss of confidence and drop in UK asset prices.”
That view sets up a tension at the heart of Reeves’ strategy: a Budget that calms markets now, but stores up doubts later about whether the promised consolidation can really be delivered.
Headroom, taxes and credibility
The centrepiece for bond investors was the bigger‑than‑expected fiscal “headroom” – roughly £22 billion in five years’ time – alongside a profile of gilt issuance that was less heavy at the long end than feared. That combination helped drive the initial rally in longer‑dated bonds and soothed memories of the 2022 mini‑Budget shock.
However, much of that headroom relies on a sharp tightening just before the next election and is heavily tax‑led rather than based on spending restraint or growth‑enhancing reform. That is exactly the mix Goodwin believes markets will gradually question.
Tax‑based consolidation is always politically harder to sustain, and when it rests on multiple smaller revenue measures rather than a few big, broad‑based changes, the risks rise further: policy U‑turns, weaker‑than‑expected behavioural responses and revenue simply not materialising.
If investors come to doubt the delivery of that tightening, they are likely to demand a higher premium for holding UK debt – even if the deficit on paper remains within the fiscal rules.
What a rising term premium means for gilts
Goodwin’s central call is not for an immediate blow‑up, but for a grind higher in the term premium – the extra compensation investors require for holding longer‑dated bonds rather than rolling short‑term debt.
In practice, that means the long end of the gilt curve could start to decouple from the Bank of England’s rate‑cutting cycle. Even as the Bank trims Bank Rate in response to cooling inflation and weak growth, 10‑ and 30‑year yields might not fall as much as borrowers and policymakers would hope – and could even rise.
For the UK, which still carries a visible “credibility scar” from the Truss‑Kwarteng episode and has the highest borrowing costs in the G7, a rising term premium would reinforce the message that investors are willing to finance the state, but only at a price that reflects persistent political and fiscal risk.
Goodwin also flags a “high risk” scenario in which some catalyst – perhaps disappointing growth, a policy reversal, or global risk aversion – sparks a more abrupt re‑pricing, with gilt yields spiking and UK asset prices under pressure.
Transmission to mortgages: less relief than borrowers hope?
For the mortgage market, the shape of the gilt curve is critical. Lenders hedge much of their fixed‑rate exposure using swaps that track medium‑dated gilts, particularly in the 2‑ to 10‑year area.
If the term premium edges up, it acts like a drag on the pass‑through from Bank Rate cuts to mortgage rates. Headline Bank Rate might move lower, but 2‑ and 5‑year swap rates – and therefore popular fixed deals – do not fall in tandem, or snap back higher more quickly on bouts of market volatility.
That suggests three implications for borrowers and brokers:
First, the window for cheaper fixes could be narrower than many expect. Recent gilt rallies have already delivered some rate cuts from lenders, but a stickier or rising term premium caps how low mainstream products can realistically go.
Second, political and fiscal news will continue to feed directly into product pricing. Any sign that the government is rowing back on planned tightening, or that the numbers no longer add up, is likely to show up quickly in swap markets.
Third, risk is skewed to the upside for longer‑term fixes. If 10‑year and 15‑year gilt yields are where the term premium is most visible, those segments could be particularly sensitive to changes in market confidence.
For households already stretched by higher living costs and frozen thresholds pulling more people into higher tax bands, even a modest gap between Bank Rate and fixed‑rate mortgages matters.
Housing market: stability now, vulnerability later
In the near term, the combination of an orderly Budget, disinflation and a central bank moving cautiously towards easing should be supportive of housing. Lower volatility in gilts and a perception that the days of emergency, Truss‑style re‑pricing are behind us may give some buyers and lenders the confidence to return.
But if Goodwin is right and the medium‑term story is one of rising term premia and a fragile risk backdrop, the housing market remains vulnerable.
A slow grind higher in long‑dated yields would keep borrowing costs elevated relative to incomes, capping price growth and weighing on highly leveraged segments such as buy‑to‑let. An abrupt loss of confidence, by contrast, could deliver another lurch higher in funding costs that tests affordability for borrowers rolling off older, cheap fixes.
The message for borrowers and intermediaries
For now, the Autumn Budget has bought Labour some credibility with bond investors and a little breathing space for borrowers. But the market’s verdict is provisional, and the hard work of sustaining that confidence – through credible delivery, coherent tax policy and realistic growth plans – lies ahead.
Intermediaries should treat the current environment as one of conditional stability, not of guaranteed, steadily falling rates. The risk that markets reassess the UK’s fiscal story – and price that directly into the cost of money – is very much alive.
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