How to read the Budget like a bond vigilante
The movement of gilt yields following the Chancellor’s speech could make or break the stock market Russ Mould
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03 November 2025 6:00am GMT
After a few decades as a daily stockpicking column, Questor returns to its 60-year-old roots by taking a weekly view of the markets – what is moving them, what lies ahead and how all of this could affect your portfolios and financial goals.
There is a simple idea that underpins all investment decisions: the riskier something is, the greater the potential reward must be to warrant that risk.
As is typically the case with investing, there is also an equation to quantify this idea.
The so-called “risk-free rate” is the benchmark by which all investments are made.
In the UK, the proxy for the risk-free rate is the 10-year gilt yield (at least in nominal, pre-inflation terms).
This is because the UK Government has never failed to pay its debts since 1672, after the Stop of the Exchequer under King Charles II (although some may argue Britain sailed very close to the wind with 1932’s restructuring of the 5pc War Loan stock).
Why would you take a chance on something that pays less than a sure thing? With yields high for a number of years, stock markets have struggled make the case for taking a chance on them instead.
The yield on UK government gilts that investors are prepared to accept (and thus oblige our Government to pay) is itself the result of many factors.
Most notable among these is the Bank of England base rate, which is inherently tied to the prevailing and expected rates of GDP growth and inflation. Other factors include supply and less tangible issues such as political credibility.
The Budget on Nov 26 has the potential to influence all of those and, in turn, how the stock market may perform.
Falling gilt yields could, on balance, be a positive factor for markets, as UK sovereign bonds will look relatively less attractive in terms of the returns they offer. Rising yields, however, could dampen appetite for UK equities, all other things being equal.
Neutral rate
The trajectory of UK interest rates is a key consideration for investment decisions, and one seasoned City bond manager provided this column a rule of thumb that they use to decide the so-called “neutral rate” for the Bank of England base rate.
Simply, this involves adding the long-term inflation rate to the long-term economic growth rate. We can find simple proxies for these.
For example, the Bank of England’s inflation target is 2pc, so that is one potential benchmark for the first half of the equation. Adding a modest outlook of 1.5pc for GDP growth suggests a fair guess for the neutral rate may be 3.5pc.
At the time of writing, the 10-year gilt yield is 4.39pc, so this calculation implies that Bank of England Governor Andrew Bailey and the Monetary Policy Committee have scope to cut interest rates further.
Of course, a spike in the rate of inflation or GDP growth would change the maths very quickly, as would a cooling of either.
Investors must devise their own base case scenario and then consider the chances of a positive or negative surprise to come to a conclusion on how attractive the UK equity market is.
Numbers game
Proving the power of surprise, that same UK equity market has confounded the doubters in 2025, with a steady march to new all-time highs.
However, using our simple ideas of both the risk-free rate and the neutral rate, we can explain why it has done so well.
According to aggregated analysts’ consensus forecasts, the FTSE 100’s members will pay out £79.4bn in dividends in 2025. On the current total stock market capitalisation for the index of £2.4tn, that equates to a forward dividend yield of 3.3pc.
Considerably lower than our risk-free rate, so why take a risk?
Such a figure does not look too compelling relative to the neutral rate either, let alone the prevailing annual rate of consumer price inflation of 3.8pc.
But there’s more to this story. The FTSE’s 100’s members are set to pay out nearly £500m in special dividends and are on course to run share buybacks worth some £55.5bn this year. The FTSE 250 may chip in a further £10bn in dividends and £2bn in buybacks.
Then come some £26bn in proceeds from takeover bids. Even if some of those arrive in the form of predators’ shares rather than straight cash, they help take the total cash inflow from UK equities to around £173bn, or 6.5pc of the FTSE 350’s total market cap of £2.7tn.
That 6.5pc figure beats the neutral rate, 10-year gilts, cash in the bank and inflation hands down – and this doesn’t even factor potential profits growth.
Red box day
Equally, bad news for the economy could surprise.
An unexpected economic slowdown or recession could lead to earnings disappointment and prompt companies to reassess their dividend and buyback policies – and maybe even frighten off would-be predators.
A growth-killing Budget would also be defined as bad news.
So, far beyond just their tax bills, voters, bond vigilantes and stock market investors have a serious stake in what happens when Chancellor Rachel Reeves takes to the despatch box on Nov 26.
But, perhaps most surprising of all, the bond vigilantes are betting things will go well.
As the big day draws nearer, 10-year gilt yields are falling, which suggests markets believe the Chancellor will meet her fiscal rules and ensure a 353-year tradition of paying debts will continue unsullied.
If this proves true, stock markets will look ever more appealing.
View this Telegraph (UK) article CLICK HERE
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