Bond investors line up to lend Boris Johnson the billions he wants to level regions, despite economists warning Prime Minister against opening spending taps by dropping his election promise in next week’s budget not to borrow to finance daily expenses.
The positive mood of the big government lenders goes against warnings that the Prime Minister’s administration would lose all credibility on public finances if it tore up the rules before they were even implemented and faced a high premium on any new loan.
This difference of opinion leaves Rishi Sunak, the new chancellor, with a dilemma as he prepares to present the budget on March 11. The Chancellor said on Sunday that he believed in “the importance of fiscal responsibility”, but officials have refused to be drawn on what it means for fiscal rules beyond the vague assurance that government plans will comply with “a budgetary framework”.
The Conservative government is struggling to increase spending on public services, while funding its promise to spend an additional £ 100 billion on infrastructure over the next five years, in accordance with its self-imposed fiscal rules.
Sunak must decide whether to abide by the party’s manifesto commitment to balance the current budget so that tax revenues at least match daily expenses, limiting the government to borrow only for investments in capital.
Despite the huge warning from economists, financial market participants said there would be few negative reactions if this rule was broken.
“I think the market would welcome it,” said Iain Stealey, head of international fixed income at JPMorgan Asset Management. “We have been austere and it doesn’t work. The monetary stimulus is driving asset price inflation but has it helped growth? It is not really clear. “
He said the move would likely slightly increase government borrowing costs, but that any increase would likely be small and short-lived and measured in hundredths of a percentage point. “You are talking about a handful of basic points,” he said.
Investor confidence that the UK government would not see a significant increase in its borrowing costs stems in part from very low interest rates around the world. Bond yields around the world, like those of British gilts, fell to record levels during the coronavirus epidemic. Yields fall when bond prices rise.
David Zahn, head of European fixed income at Franklin Templeton, said that in this climate, UK government bonds would attract investors from around the world. “If you see that gilding yields suddenly go up, there will be demand from outside the UK.”
HSBC analysts predict that UK issues during the 12-month period ending in April 2021 will reach £ 155 billion, an eight-year high. “You can see gilts underperforming compared to other markets,” said Daniela Russell, head of HSBC UK rate strategy, who said buyers would ultimately be influenced by the economic outlook. widest in the UK.
Mike Riddell, a fund manager at Allianz Global Investors, said there was no reason why Britain should not be able to run a large deficit as the Bank of England could resort to buying much of the new debt as part of so-called quantitative easing. “Even if the UK ends up borrowing a lot more than expected, if things get bad enough, the Bank of England cuts rates and QE.”
Economists do not dispute investors’ view that appetite for gilts is abundant, but fear that if fiscal rules are broken so easily, subsequent constraints will lack credibility and the government may soon lose control of finances public.
The Institute for Fiscal Studies said last week that abandoning a manifesto rule so quickly “would surely undermine any credibility attached to the fiscal targets set by this government.”
Thomas Pope, an economist at the Institute for Government, added that the interest of tax rules is not so much to limit borrowing costs as “to avoid the temptation to borrow more, leaving future generations the consequences “
In the aftermath of the financial crisis, a massive increase in government borrowing was accompanied by a fall in bond yields as the BoE launched an asset purchase program. Robert Stheeman, who heads the UK debt management office, told FT in January that he was “very confident” that the market would be able to absorb a further sharp increase in gilding emissions.
Although the size of the UK’s debt has continued to increase, low interest rates make it cheap. Government paid £ 38.5 billion in interest in fiscal year 2018-2019, the lowest level relative to the size of the economy since 2003-2004, at 1.8% of GDP .
There are, however, dissenting voices on both sides. Some fund managers anticipate higher yields. “I think the market is not valued for substantial fiscal easing – especially given the position of the current government – so, if fiscal stimulus were to be implemented, it could have a significant impact on markets, “said Scott Thiel, chief fixed income strategist. at the BlackRock Investment Institute.
In contrast, Martin Beck, a British economist at Oxford Economics, said that a change to the current balanced budget rule “would not bring the roof down.”
In fact, investors have said that any sustained increase in borrowing costs would likely reflect growing confidence in the UK economy at home and abroad, which could prompt the BoE and other central banks to raise rates. , rather than a sign of concern about debt sustainability.
“Higher yields would be a sign of success, not failure,” said Mark Dowding, chief investment officer at Bluebay Asset Management.
Bond investors line up to lend Boris Johnson the billions he wants to level regions, despite economists warning Prime Minister against opening spending taps by dropping his election promise in next week’s budget not to borrow to finance daily expenses.
The positive mood of the big government lenders goes against warnings that the Prime Minister’s administration would lose all credibility on public finances if it tore up the rules before they were even implemented and faced a high premium on any new loan.
This difference of opinion leaves Rishi Sunak, the new chancellor, with a dilemma as he prepares to present the budget on March 11. The Chancellor said on Sunday that he believed in “the importance of fiscal responsibility”, but officials have refused to be drawn on what it means for fiscal rules beyond the vague assurance that government plans will comply with “a budgetary framework”.
The Conservative government is struggling to increase spending on public services, while funding its promise to spend an additional £ 100 billion on infrastructure over the next five years, in accordance with its self-imposed fiscal rules.
Sunak must decide whether to abide by the party’s manifesto commitment to balance the current budget so that tax revenues at least match daily expenses, limiting the government to borrow only for investments in capital.
Despite the huge warning from economists, financial market participants said there would be few negative reactions if this rule was broken.
“I think the market would welcome it,” said Iain Stealey, head of international fixed income at JPMorgan Asset Management. “We have been austere and it doesn’t work. The monetary stimulus is driving asset price inflation but has it helped growth? It is not really clear. “
He said the move would likely slightly increase government borrowing costs, but that any increase would likely be small and short-lived and measured in hundredths of a percentage point. “You are talking about a handful of basic points,” he said.
Investor confidence that the UK government would not see a significant increase in its borrowing costs stems in part from very low interest rates around the world. Bond yields around the world, like those of British gilts, fell to record levels during the coronavirus epidemic. Yields fall when bond prices rise.
David Zahn, head of European fixed income at Franklin Templeton, said that in this climate, UK government bonds would attract investors from around the world. “If you see that gilding yields suddenly go up, there will be demand from outside the UK.”
HSBC analysts predict that UK issues during the 12-month period ending in April 2021 will reach £ 155 billion, an eight-year high. “You can see gilts underperforming compared to other markets,” said Daniela Russell, head of HSBC UK rate strategy, who said buyers would ultimately be influenced by the economic outlook. widest in the UK.
Mike Riddell, a fund manager at Allianz Global Investors, said there was no reason why Britain should not be able to run a large deficit as the Bank of England could resort to buying much of the new debt as part of so-called quantitative easing. “Even if the UK ends up borrowing a lot more than expected, if things get bad enough, the Bank of England cuts rates and QE.”
Economists do not dispute investors’ view that appetite for gilts is abundant, but fear that if fiscal rules are broken so easily, subsequent constraints will lack credibility and the government may soon lose control of finances public.
The Institute for Fiscal Studies said last week that abandoning a manifesto rule so quickly “would surely undermine any credibility attached to the fiscal targets set by this government.”
Thomas Pope, an economist at the Institute for Government, added that the interest of tax rules is not so much to limit borrowing costs as “to avoid the temptation to borrow more, leaving future generations the consequences “
In the aftermath of the financial crisis, a massive increase in government borrowing was accompanied by a fall in bond yields as the BoE launched an asset purchase program. Robert Stheeman, who heads the UK debt management office, told FT in January that he was “very confident” that the market would be able to absorb a further sharp increase in gilding emissions.
Although the size of the UK’s debt has continued to increase, low interest rates make it cheap. Government paid £ 38.5 billion in interest in fiscal year 2018-2019, the lowest level relative to the size of the economy since 2003-2004, at 1.8% of GDP .
There are, however, dissenting voices on both sides. Some fund managers anticipate higher yields. “I think the market is not valued for substantial fiscal easing – especially given the position of the current government – so, if fiscal stimulus were to be implemented, it could have a significant impact on markets, “said Scott Thiel, chief fixed income strategist. at the BlackRock Investment Institute.
In contrast, Martin Beck, a British economist at Oxford Economics, said that a change to the current balanced budget rule “would not bring the roof down.”
In fact, investors have said that any sustained increase in borrowing costs would likely reflect growing confidence in the UK economy at home and abroad, which could prompt the BoE and other central banks to raise rates. , rather than a sign of concern about debt sustainability.
“Higher yields would be a sign of success, not failure,” said Mark Dowding, chief investment officer at Bluebay Asset Management.