Another UK public borrowing blow for Reeves, as stocks remain subdued

• Contrasting fortunes of FTSE 100 and public purse.
• Why inflation is pushing up borrowing.
• UK Gilts: from hero to zero.
• Stocks remain subdued as tariff risks mount.
• The oil price could be heading for a decline.

There has been mixed fortunes for the UK this week. On the one hand, the FTSE 100 made another record high and closed above the 9,000 level for the first time. So far this year, the FTSE 100 has risen by 10% in USD terms, and 18% in sterling terms, and it’s outperforming the Eurostoxx index, the Dow Jones, the S&P 500 and the Nasdaq.

However, the FTSE 100’s fortunes are not a reflection of the domestic economy. Earlier this morning we got more bad news about the UK’s public finances. The UK borrowed much more than expected last month, public sector net borrowing was £20.7bn, a whopping £6.6bn more than a year ago, and the second highest borrowing for June on record. Borrowing in the first 3 months of the fiscal year was £57.8bn, roughly in line with OBR forecasts.

What’s driving public sector borrowing

Blowing past borrowing expectations is becoming the norm, and that fact that borrowing is surging compared to a year ago, could be seen as a sign that the government has lost control of the UK’s public sector finances. However, it cannot all be blamed on Rachel Reeves. The Office for National Statistics blamed the increase in borrowing on the rising costs of providing public sector services, this includes pay rises given to public sector workers in the past year. It also said that the cost of servicing our debts rose significantly last month, as the interest paid on index-linked gilts helped to push up overall spending.

Why higher inflation is pushing up UK debt costs

Index-linked gilts could be a problem for some time to come, as the UK’s inflation figures are the strongest in the G13. For example, the UK’s inflation rate is currently 3.6% YoY, this compares to 2% in Germany and 1% in France. The inflation differential is playing havoc with the UK’s public finances, at a time when financial markets are starting to keep a close eye on high levels of government borrowing.

This is likely to lead to even more speculation that taxes will rise in the October Budget, for the second time under Labour. The issue for the country is that ever-growing public sector costs could lead to consistent tax rises over this parliament. The government’s unwillingness to rein in spending and the lack of realistic debate about public sector services and how much the state can provide could leave the UK in a very tricky position. The prospect of an increasing tax burden plus surging costs for providing public services will naturally lead to a discussion about the cost effectiveness of the UK state, especially if there is a public outcry about higher taxes later this year.

The market impact

The pound is lower on Tuesday; however, the dollar is the strongest performer in the G10 FX space on Tuesday, and the pound is not a standout underperformer. GBP/USD has slipped below the $1.3450 mark, and regaining $1.35 could be trickier after the release of this data. The spotlight will be on UK Gilts today, if there is a sharp rise in yields on the back of this data then we could see the pound start to sell off at a faster pace.

UK Yields fell sharply on Monday and were the top global performer, however, it’s hero to zero on Tuesday. UK yields are climbing after the public sector borrowing data, the 10-year yield is higher by 3bps, and there are gains across the curve. UK Gilts are now the underperformers. Although German, French, Canadian and Japanese yields experienced larger increases than UK yields so far this year, in the past month, UK yields have climbed at a faster rate, which is a sign that concerns are growing about the outlook for the UK economy as we move towards the Budget.

Stocks remain subdued as tariff talks progress stalls

Elsewhere, stocks are weaker on Tuesday, although the FTSE 100 is managing to stay above the 9,000 level. US stock index futures are also pointing to a lower open. The lack of progress on US Trade negotiations, combined with some key tech earnings that are coming up on Wednesday, could see stocks trade with a mild risk off sentiment.

Why the Oil price could be heading lower

Weakness across the commodity space, including lower oil prices, could weigh on the energy sector today, but it may also limit stock market declines, as a subdued oil price could boost economic growth in the coming months. The oil price has remained subdued so far this summer, which tends to be peak demand. This suggests that as demand wanes as we move into Autumn, the oil price could come under downward pressure in the coming weeks and months.