U.K. Bond Vigilantes: Saddle Up!
(Bloomberg Opinion) -- Last week’s shock resignation of Sajid Javid from his perch as U.K. chancellor of the exchequer is widely expected to facilitate a more profligate fiscal stance by the government. If the well-flagged increase in spending isn’t accompanied by higher taxes, bond yields could well head higher — especially if the Bank of England responds by adopting a more hawkish stance on interest rates.
Javid’s replacement by his deputy Rishi Sunak will dilute the natural conflict between a big-spending prime minister and the Treasury minister in charge of the purse strings. Javid had been keen to increase taxes to pay for at least some of the upcoming splurge — a mansion tax, anathema to Conservative governments in the past, was even floated recently — while Sunak is deemed more likely to acquiesce to Boris Johnson’s desire to go gangbusters on resuscitating the economy by relying instead on raising more debt.
The Treasury's fiscal rule of limiting the budget deficit to no more than 3% of gross domestic product could be relaxed further, as could the commitment to balance the budget by the end of this five-year parliament. The gilt market has been waiting for several months for clarity on how much supply it will have to absorb, as the Autumn statement was canceled due to the December election.
The budget, due on some now unspecified day next month, will reveal all. Market expectations were for an increase from this year's total of 137 billion pounds ($178 billion) to at least 175 billion pounds in the coming financial year starting in April. But those estimates are now likely to rise further.
If the overall tax burden isn't increased, something has to give — and most likely that will be the cap on borrowing. With gilt yields so low, more borrowing may prove too tempting to resist.
The bond market has thus far taken the prospect of more supply in its stride; and while yields are close to record lows, they still offer a premium compared with core European government bonds. Since Johnson's emphatic election win on Dec. 12, 10-year gilt yields have fallen by about 20 basis points despite further confirmation of the new government's ambitious spending plans. The green light given to the HS2 high-speed rail link, the biggest infrastructure project in Europe with costs expected to exceed 100 billion pounds, is a signal of major intent.
The pound has enjoyed a modest bounce since the changing of the guard at the Treasury, in part because of expectations that a bigger fiscal stimulus delivered by the government will lessen the need for monetary intervention. Interest rates were kept on hold at last month’s meeting, although the futures market had been pricing in a 50% chance of a cut after a series of comments from members of the monetary policy committee suggesting that an easing might be deemed necessary.
In a series of valedictory interviews in recent days, Bank of England Governor Mark Carney commented on both the past and the potential future of monetary policy, with a remark about the government’s likely spending ambitions that only an outgoing chief would be bold enough to make. He told Bloomberg Television that he felt fortunate to depart without having gone to negative rates, adding, “I’m not a huge fan.” And he mused on the fiscal outlook in an interview with Reuters:
In an environment where everything is getting a fresh look, it’s fertile ground for taking a step back and making bigger changes than otherwise might have been made. It’s early days but there are several initiatives — the budget will be telling — that suggest that some of these opportunities are being grasped.
Andrew Bailey, Carney’s replacement, is scheduled to take the helm of the central bank in the middle of next month. The more the government does to prime the economic pump, the less active he’ll need to be. But if the motivation for the fiscal boost is perceived to be rewarding voters for the December election outcome rather than serving the needs of the broader economy, the Bank of England may respond by growing more hawkish. Bond investors will be need to be wary.
To contact the authors of this story: Mark Gilbert at magilbert@bloomberg.netMarcus Ashworth at mashworth4@bloomberg.net
To contact the editor responsible for this story: Melissa Pozsgay at mpozsgay@bloomberg.net
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable."
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
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