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UK government set to unveil major tax hikes

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Fiscal credibility seen as crucial, analysts say

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U.S. Treasury-Bund yield spread at lowest in over two

months

By Stefano Rebaudo

Nov 26 (Reuters) - Euro zone government bond yields

edged higher after three consecutive sessions of declines, with

the U.S. Treasury-Bund spread hovering near its lowest level in

over two months, as investors await the UK budget.

Britain's announcement will be closely watched, with Finance

Minister Rachel Reeves expected to unveil tax increases worth

tens of billions of pounds.

Germany's 10-year yields, the euro zone's

benchmark, rose 0.5 basis points (bps) to 2.68%.

Yields on 10-year UK gilts were up one bp at

4.50%.

"Now that Reeves has ruled out an income tax hike, fear the

budget will not reduce the deficit enough to satisfy

bondholders, especially given that the government has borrowed

more than expected already this year," said Man Group's chief

market strategist Kristina Hooper.

"Businesses are worried about which tax increases will be

implemented," she added.

FISCAL CREDIBILITY IN FOCUS

Analysts expect the risk premium on UK government bonds to

remain elevated for long-dated gilts with fiscal credibility in

focus, while the budget's economic impact could hurt the economy

and lower terminal rate pricing.

UK 30-year gilt yields, more sensitive to

long-term fiscal concerns, rose one bp to 5.34%.

"Our best guess is that the initial market reaction (to the

UK budget) may be mildly bullish for gilts, with risks of

steepening if long issuance isn't cut," said Jamie Searle, rate

strategist at Citi.

"However, this may not be the lasting reaction, which might

depend more on how the Budget lands with respect to political

uncertainty," he added.

Benchmark 10-year U.S. Treasuries yields were up

0.5 bps at 4.0%, after falling for a fourth straight session the

day before when data reinforced expectations the Federal Reserve

will cut interest rates next month.

The spread between U.S. Treasuries and Bunds

was at 132.50 bps. It hit 132.16 on September 17, its lowest

since early April.

The U.S.-German spread widened sharply in early April after

U.S. President Donald Trump announced tariffs on major trading

partners, triggering a sharp selloff in all U.S. assets,

including government bonds.

It tightened recently as traders ramped up bets on Federal

Reserve rate cuts while expecting the European Central Bank to

stay firmly on hold.

Traders priced in around a 40% chance of an ECB

25-basis-point rate cut by September while

expecting the key rate to be at 1.95% in March 2027 from the

current 2%.

Germany's 2-year yields, more sensitive to

expectations for ECB policy rate outlook, dropped 0.5 bps to

2.01%. They hit 2.051% last week, the highest level since March

28.