"For bond markets, the detailed funding plan, along with the credibility of government debt and deficit projections, is likely to be important too."
AJ Bell's investment director Russ Mould said: "If Liz Truss can put an end to the sell-off in both the UK government bond market and sterling that would be a major coup," though he too said the odds were very much stacked against her.
He added: "Sterling may be sliding but government borrowing costs are soaring, to suggest that the bond market does not think too much of what it sees in the UK, either – although the Bank of England’s interest rate rises in its belated battle to rein inflation back in has a big role to play here, too."
UK 10-year gilt yields, though low by historic standards, are within touching distance of the 3 per cent mark for the first time since early 2014, he said.
Recession ahead?
The yield curve is now inverted, meaning in August the yield on the two-year gilt moved up faster than that of the 10-year, meaning the shorter-term paper offered a higher yield.
“This is usually a sign that the bond market is pricing in a recession, as it anticipates future interest rate cuts, and thus a drop in borrowing costs," said Mould.
“It is by no means a flawless indicator – nothing is ever that easy from an investment point of view – but the UK yield curve inverted ahead of the 1991-92 downturn and the deeper 2007-09 recession.
"While the inversions of 1998 and 2000 proved false signals, they did reflect concerns over the potential for the stock market’s bust in technology, media and telecoms stocks to spill into, and weigh on, the real economy."
He added: "The new prime minister will find themselves potentially trapped between the lesser of two evils of inflation on one side and recession on the other.
"If the financial markets like what they hear then that may help to hold gilt yields in check, the yield curve to steepen and the pound to rally. If not, then yields could rise, the curve continue to invert and sterling may keep sliding."
Quintet Private Bank recently downgraded its growth forecasts and expects the UK to enter recession in the final month of the third quarter of this year (September) or in Q4, with overall economic activity contracting for about three quarters in a row.
Antonucci said: "While not a done deal, we believe that a 50bps rate hike to 2.25 per cent at the September 15 monetary policy meeting of the Bank of England is likely, though a step-up to 75bps is possible too.
"Even though we expect a 50-75bps rate hike to 0.50-0.75 per cent on September 8 for the European Central Bank too, the bigger/faster fiscal stimulus in the UK and the somewhat milder recession we envisage in the UK would suggest more upside risks to the Bank of England rate path versus the European Central Bank.”
