By William Schomberg and David Milliken

LONDON (Reuters) – Rachel Reeves is facing her first major test since becoming Britain’s finance minister after a jump in the government’s borrowing costs this week and a deepening of the pound’s losses on Thursday, potentially forcing her to cut future spending.

With investors worrying about high borrowing and a stagnating economy, the Treasury said there was no need for intervention to calm markets, having vowed late on Wednesday to maintain “an iron grip” on the public finances.

A selloff in debt markets on Tuesday and Wednesday – which has been linked in part to the imminent arrival in the White House of Donald Trump – pushed the yield on 30-year British government bonds – or gilts – to a 26-year high.

Gilt prices slumped further at the start of trading on Thursday – driving yields to fresh highs – before recovering to stand little changed on the day.

The pound was headed for its biggest three-day drop in nearly two years, prompting comparisons with the 2022 “mini-budget” crisis that forced former prime minister Liz Truss out of Downing Street.

However, this week’s market moves have been less sharp and there has so far been no evidence of the strain on institutional investors that forced the Bank of England into emergency bond purchases in 2022.

Treasury minister Darren Jones, Reeves’ deputy, told parliament the UK bond markets “continue to function in an orderly way” and demand for UK debt remained strong. “There is no need for any emergency intervention,” Jones said.

The Conservative opposition party accused Reeves of being “missing in action” and called on her to scrap a trip to China aimed at reviving trade ties. She was due to depart on Thursday.

PIMCO, one of the world’s largest bond investors, said it was still positive about UK bonds and said that shifts in the U.S. debt market ahead of Trump’s presidency were largely to blame.

“Although UK-specific factors, such as the budget, have contributed to the rise, most of the increase has been driven by rises in U.S. Treasury yields during the same period,” PIMCO economist Peder Beck-Friis said.

Britain’s new government launched its plan for more investment in public services and infrastructure to boost economic growth just days before Trump’s Nov. 5 election victory which pushed up borrowing costs globally.

That shift in markets has made investors more worried about the combination of high borrowing in Britain planned by Reeves and Prime Minister Keir Starmer, and the impact of their higher taxes for business on an economy that is now stagnating.

A survey of recruiters showed that vacancies slumped in December, while shares in Britain’s Marks & Spencer and other retailers fell due to concerns about weak consumer confidence.

Analysts at Citi said British bonds were being hit by worries about the extent of the government’s borrowing plans, which could keep pressure on inflation and prevent the BoE from cutting interest rates quickly to help the economy.

“The market appears to be questioning the credibility of the fiscal plans, especially with another full fiscal event not due until the autumn,” they said in a note to clients.

Britain is due to issue nearly 300 billion pounds ($368 billion) of government bonds over the coming financial year.

Some analysts said Britain’s departure from the European Union had made it more exposed to swings in financial markets.

“Brexit UK is vulnerable as a less core asset in global investor portfolios,” Krishna Guha and Marco Casiraghi at Evercore ISI, a consultancy, said in a report.

Others said the rise in market interest rates would make it easier for the BoE to cut borrowing costs, potentially easing the pressure on gilt yields and the government’s coffers.

“The recent sharp tightening in financial conditions, which poses downside risks to the UK economic outlook, reinforces the case for BoE easing,” Simon Dangoor, head of fixed income macro strategies at Goldman Sachs Asset Management.

OUT OF WIGGLE ROOM

In her Oct. 30 budget, Reeves gave herself only a small margin of error for meeting her target of balancing spending on public services with tax revenues by the end of the decade.

Economists think the rise in borrowing costs and economic stagnation since July’s election mean Reeves is off course to hit that target and that she will need to respond.

Reeves has previously said she does not plan further big tax increases after her hike in social security contributions for employers from April prompted protests from corporate leaders.

Instead, she could announce spending cuts for future years, but that would risk being seen as a return to what she derided as austerity under the previous Conservative governments.

Jones told parliament the government would stick to its existing spending plans but declined to directly address questions about whether further tax rises could be ruled out.

Reeves will deliver a budget update on March 26 when official fiscal forecasters will say whether she is on course to meet her targets.

She has said she favours only one budget announcement a year in the autumn.

But Matthew Amis, an investment manager at fund management firm abrdn, predicted that Reeves would probably be forced to announce spending cuts in March.

“The UK is borrowing a lot this year, investors need confidence to buy that debt otherwise gilt yields will continue to move higher and the currency will continue to weaken,” Amis said.

($1 = 0.8144 pounds)

(Additional reporting by Harry Robertson and Muvija M; Graphics by David Milliken and Andy Bruce; Writing by William Schomberg; Editing by Christina Fincher, Tomasz Janowski and Toby Chopra)

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