There is a change in the leadership of the British political arena, with the new Chancellor of the Exchequer taking over the "hot potato": fiscal borrowing exceeding expectations, putting pressure on the bond market again.

On July 21, the data released by the UK Office for National Statistics (ONS) showed that in the first three months of the 2026/27 fiscal year (April to June), the UK public sector net borrowing reached 57.6 billion (approximately $77.5 billion), exceeding the forecast by 2.7 billion made by the Office for Budget Responsibility (OBR) in March. Despite a significant one-third decrease in the deficit in June compared to the previous month to 16 billion, better than the economists' expectations of 17.8 billion, the deficit for the first quarter still exceeded official expectations, sounding the alarm for the new Chancellor of the Exchequer. On Monday, the UK political scene welcomed its seventh Prime Minister in ten years. On July 20, Andy Burnham officially took over from Keir Starmer as the new resident of 10 Downing Street. He then unexpectedly appointed John Healey as the Chancellor of the Exchequer. However, Burnham's statement on his first day in office about "using all flexibility within fiscal rules" immediately triggered the most sensitive nerves of the market the yield on the 10-year UK government bonds jumped by 9 basis points to 5.04%, while the 30-year yield rose to a two-month high of 5.75%. The next day, with the market sentiment slightly calming down, the yield on the 10-year government bonds dropped slightly by 1 basis point to 5.02%. The statement on "flexibility": Market tension and Burnham's reassurance The trigger for market tension was Burnham's statement to reporters on the afternoon of July 20. When asked if it was possible to increase borrowing to provide funds for larger-scale infrastructure investments, Burnham said, "I've said we will stick to fiscal rules I mean the existing fiscal rules and obviously use any flexibility within them." He then tried to reassure the market: "This is not about putting the UK economy at risk. I have never done that in any role I've had in the past... I've always taken a very cautious approach." He also promised to "explain how the funds will be raised and will clearly set out in the budget". However, these statements did not prevent the immediate reaction of the bond market. The 10-year government bond yield rose by 9 basis points to 5.04%, and the 30-year yield rose by 9 basis points to 5.75%. The pound fell by 0.27% against the US dollar to $1.3416. Evelyne Gomez-Liechti, a strategist at Mizuho Securities, pointed out, "The market is highly sensitive to any specific statements regarding fiscal rules." The shadow of the 2022 Liz Truss tax-cutting budget disaster without financial support is still looming, and investors remain highly vigilant to any signals that may relax fiscal discipline. Burnham also hinted at a possible increase in the income tax rate for highest earners to 50%, while raising the tax-free threshold these policy signals further heightened concerns in the market about fiscal looseness. Healey's "hot potato": From defender of defense spending to approver of finances Healey's appointment itself was dramatic. Just six weeks ago, he resigned as Defense Secretary due to dissatisfaction with the Starmer government's refusal to commit to increasing defense spending to 3% of GDP by 2035. Now, he has gone from being a "defender" of defense spending to an "approver" - this reversal of roles makes military spending the most watched variable in his fiscal policy. Upon taking office, Healey immediately stated: "Fiscal control is the first responsibility of any Chancellor of the Exchequer, and it is my responsibility. Fiscal credibility is the foundation of economic stability and national security." He also promised to work "in sync with Burnham, while adhering to fiscal rules and reserving cushion space to deal with uncertainty". However, the challenge is multifaceted. In addition to the pressure on defense spending, Healey also faces multiple demands for spending on welfare reform, tax cuts for energy bills, and expanding public utility "control." Martin Beck, chief economist at WPI Strategy, warned, "Political pressures will likely use any improvement in borrowing figures to fund new commitments, while the fiscal pressures remain to protect these improvements as a buffer against higher debt interest and future economic shocks." Two "lucky breakthroughs": Why hasn't the market collapsed yet? Despite the tension in the bond market, the UK has not experienced a bond market collapse like the Liz Truss tax cuts without financial support in 2022. Analysts believe that Burnham has at least two key "lucky breakthroughs." First, the fiscal legacy left by former Chancellor Reeves. Reeves strictly adhered to fiscal rules during her term, and this year the UK government bond sales have significantly decreased by 58 billion to approximately 246 billion. James Smith of ING pointed out that this level should be enough to cover most of the tax and expenditure adjustments hinted at by Burnham so far. The UK is currently a rare example of "economy truly experiencing fiscal austerity" due to the freezing of tax thresholds. Second, the optimistic signal from the International Monetary Fund (IMF). In its July World Economic Outlook report, the IMF raised its economic growth forecast for the UK in 2026 from 0.8% to 1.0%, making the UK the third-fastest-growing economy among G7 countries, behind only the US (2.3%) and Canada (1.1%). The IMF has maintained its forecast for UK economic growth in 2027 at 1.3%. This moderate upward adjustment suggests that the economic situation Burnham is inheriting may not be as dire as previously feared. In addition, the Resolution Foundation has suggested that the government could increase borrowing by expanding the functions of public financial institutions such as the National Wealth Fund the additional borrowing by these institutions does not count towards the government's self-imposed debt rules, providing Burnham with potential fiscal operating space. Interest expenses sharply declining in June as a "pressure relief valve", but structural pressures remain unresolved The main driver of the significant decrease in the deficit in June was the significant decrease in interest expenses. The central government's debt interest payments in that month amounted to 11.8 billion, a 31% decrease year-on-year (about 5.3 billion), mainly due to inflation slowing down and reducing the interest costs linked to the retail price index. However, this was still the fourth-highest interest expense level in June. Positive signals also came from tax revenues. ONS pointed out that tax revenues, especially from income tax and value-added tax, showed strong growth in June. These improvements were partly offset by a sharp increase in welfare spending. Martin Beck, chief economist at WPI Strategy, commented, "The borrowing data in June is undoubtedly a shot in the arm for the new government, but this should not be mistaken for a turning point. It is just providing some breathing space for the new Chancellor after a difficult start to the fiscal year." However, cumulative data reveal a more dire reality. While fiscal revenues were 2.4 billion higher than OBR's forecast in the first three months, spending exceeded by 3.6 billion. Rachel Reeves's fiscal rule of achieving regular budget balance in the 2029-30 fiscal year has not yet been met. In April to June, the public sector net borrowing was 42 billion, nearly 11% lower than the same period last year, but still 1.3 billion higher than OBR's forecast. Total borrowing so far this fiscal year has reached 57.6 billion, down by 6% compared to the same period last year, but still 2.7 billion higher than OBR's forecast. The public sector net debt as a percentage of GDP is approximately 100%, just about 100 billion away from the 3 trillion mark. Bank of England may delay interest rate hike With inflation pressures easing, including a reduction in the September energy price cap, the likelihood of the Bank of England maintaining interest rates at its meeting on July 30 has increased. Data released earlier showed that the UK's inflation rate in May unexpectedly remained stable, indicating that even before a peaceful agreement between the US and Iran led to a significant drop in energy prices, the pressure on prices was smaller than feared. The Consumer Price Index (CPI) rose by 2.8% year-on-year in May, matching April's rate and lower than economists' expectations of 3%. Data released on Tuesday showed that the growth in private sector wages dropped to its lowest level since 2020. The UK Office for National Statistics stated that the three-month average wage growth excluding bonuses remained at 3.4% year-on-year as of May. The private sector wage growth, which is the most important focus for the Bank of England, grew by 2.9% year-on-year in the three months ending in May, the slowest rate since October 2020. The market currently expects that the Bank of England will maintain interest rates at its next meeting. Trading desks currently estimate a 14% probability of a 25-basis-point rate hike by the Bank of England. However, due to renewed tensions between the US and Iran, investors still anticipate that the Bank of England may take action to raise rates by the end of the year. Political risks: Shadow of the Reform Party and countdown to the election In addition to the fiscal variables that the market is focused on, political risks should not be ignored. At the time of Burnham's appointment, the right-wing Reform UK party, while still leading in the polls, is losing its lead. According to the latest poll conducted by Opinium for The Observer, support for the Reform UK party has fallen to 23%, leading the Labour Party by only 1 percentage point. A poll by Survation also showed the two parties tied at 24%. This is the first time in over a year that the Labour Party has been neck and neck with the Reform UK party. Nigel Farage, leader of the Reform UK party, is currently under investigation by Parliament for failing to declare a 5 million donation, which is affecting his support rate. However, the Reform UK party remains a variable that cannot be ignored. For most investors, a Reform UK government would be an unpredictable variable - many find it difficult not to compare it to the disastrous budget of Truss in 2022. The IMF warned in July's report that the turmoil in the UK government bond market in September 2022 "seems to mark a fundamental shift in the way shocks are transmitted to government bond yields", intensifying market fragility. The time pressure facing Burnham is also urgent. The next general election in the UK must be held within three years, and analysts point out that Burnham's significant reforms "almost have no time to bear economic fruit." By forcibly cutting welfare spending, it is more likely to provoke a backlash within the Labour Party. Conclusion Burnham's first day was a carefully orchestrated balancing act. He must not only reassure the left wing of his party with his statement on "flexibility" in fiscal expansion but also reassure the bond market with his commitment to "cautious approach" towards fiscal discipline. Healey's appointment - a former Defense Secretary who resigned over the demand to increase defense spending becoming Chancellor of the Exchequer - is the most dramatic part of this balancing act. The borrowing costs for the UK are currently the highest in the G7. The 10-year government bond yield is hovering around 5% - a level that has not been surpassed since spring 2026. Public debt as a percentage of GDP is 94.9%, the highest in 60 years. However, the two "lucky breakthroughs" - the fiscal space left by Reeves and the growth forecast adjustment by the IMF - provide Burnham with a brief respite. The true test will come in the autumn budget: how to fulfill welfare commitments, bridge the defense spending gap, advance infrastructure investments while not triggering a bond market collapse, and also deal with the political pressures of the upcoming election within three years. As James Smith of ING said, "a dull budget will not win an election." But for Burnham, an "interesting" budget may also lose market confidence. This Damocles sword will hang over his entire term as Prime Minister.