How new UK finance minister's first budget could affect markets

By Alun John and Samuel Indyk

LONDON, Oct 27 (Reuters) - Britain's new finance minister, John Healey, delivers his first budget on Wednesday against a backdrop of rising global borrowing costs and high energy prices due to the Iran war.

Budgets are typically a key event for UK markets, especially since 2022 when a former government's mini-budget and its plan for unfunded tax cuts sparked a bond market rout.

Since then, politicians have stressed fiscal discipline.

Here is a look at what is at stake for UK markets.

BOND SELLOFF STINGS

A global bond selloff will add to the government's interest bill, eroding a fiscal buffer that stood at £24 billion ($32 billion) in March.

Economists estimate it is down to between £8.5 billion and £20 billion.

Investors want reassurance over fiscal discipline, and they will watch borrowing plans for the coming 12 months announced after the budget.

Healey is under pressure to meet ⁠his fiscal rules without raising any of the main taxes.

Still, relative political stability, better economic data and the Bank of England's decision to pause its gilt sales have lifted sentiment.

It also could be worse. Britain's 10-year borrowing costs are up almost 30 basis points to around 5.33% since the start of September. France's, while lower at 5.05%, have risen 86 bps.

"It's hard to be immune in an environment where global bond yields are going higher, but among major developed markets, the UK is looking like one of the cleanest dirty shirts out there," said Guillermo Felices, PGIM's global investment strategist.

STERLING SHRUGS

Sterling, at a 17-month peak against the euro, appears unfazed.

Brighter economic data has supported the pound, and FX options show little sign of traders seeking protection against budget-related drama.

"We are struck by the relative calm in UK markets," say BofA currency analysts. However, despite being long-standing sterling bulls, they have turned more cautious ahead of the budget, pointing to "some risks of complacency."

TAX THE BANKS?

As the government looks for additional revenue to shore up its public finances without imposing broad tax rises, banks are sensitive to any signs that they could be targeted for a tax raid.

Media reports have said Healey plans to tax banks, potentially by increasing the 3% surcharge that banks pay on their profits.

Shares of the big four banks — HSBC, NatWest, Lloyds and Barclays — are down between 6% and 11% in October so far. While this is broadly in line with other European banks given higher global borrowing costs, pre-budget jitters are partly to blame.

"There's been commentary from the government that would lead you to conclude that they've decided the time is right to lean on banks a little more, and I wouldn't be surprised if there was a relatively neutral reaction," said Dominic Younger, portfolio manager for CT Progressive Income at Columbia Threadneedle.

He believed a move was now priced in.

SOME SINS ARE BETTER THAN OTHERS

Gambling companies will be watching for a possible rise in the Machine Gaming Duty, a tax on the net takings from some fruit machines, slot machines and quiz machines.

The Times newspaper reported that the duty could rise by 5 percentage points to 25%, materially lower than a rise to 40% that a large group of ruling Labour Party politicians were pushing for. Shares in Entain and Flutter Entertainment are both up about 10% in October.

Pub chains have already seen a business rate cut and Prime Minister Andy Burnham's fondness for the sector may offer some hope that it escapes the worst of any tax rises.

"The prime minister has made it fairly clear that his affinity for the pub sector means he's not going to be layering costs on for them," said Columbia Threadneedle's Younger.

Recent strong trading updates from London-listed pub operators such as Wetherspoon, Mitchells & Butlers, Marston's and Fuller Smith & Turner have pushed shares up between 10% and 25% this month.

BUDGET BOOST FOR BUILDERS?

Housebuilder stocks surged in late September after the government confirmed plans for a new first-time buyer support scheme, boosting a sector battered by weak demand and affordability pressures.

"We believe this is the big catalyst the sector as a whole needed for a re-rating," said RBC analyst Anthony Codling after the plans were announced.

"Christmas has come early for the UK housebuilders."

But rising bond yields and mortgage rates have since acted as a headwind, with pre-budget share gains being almost completely wiped out.

(Reporting by Samuel Indyk and Alun John, Editing by Dhara Ranasinghe and Hugh Lawson)