British markets were spared the painful blows of the new Labor government’s first budget on Wednesday, which announced 40 billion pounds of tax rises to plug deficits, but eased fears of an explosion in public spending and disorder in the debt market.
Finance Minister Rachel Reeves balanced significant increases in debt and investment with promises of tight controls on day-to-day spending, allaying investors’ fears of a repeat of the country’s chaotic September 2022 mini-budget. Liz Truss, then Prime Minister.
Government borrowing costs, as measured by 10-year gilt yields, rose to their highest level since May, at around 4.38%, but the move remained modest compared to the surge in two years ago. Meanwhile, the pound rose and the domestically focused FTSE mid-250 index briefly jumped more than 1.5%.
“Investors feared another Liz Truss moment, but ultimately the announcements do not suggest an uncontrolled increase in debt,” said Nabil Milali, portfolio manager at Edmond de Rothschild Asset Management.
PRE-BUDGETARY NERVOUSNESS
Investor nervousness ahead of the Budget increased after data showed UK public borrowing had reached almost 100% of GDP and Mr Reeves blamed the former Conservative government, replaced by the party Labor in July’s landslide election victory for creating a £22 billion budgetary “black hole”.
In a sign of the malaise, shares of British retailers and pub operators fell for several days and government bond yields rose.
But after Mr Reeves outlined investment spending of around £100bn over the next five years on Wednesday and shifted the tax bite towards businesses rather than workers, the FTSE 250 index ended Wednesday higher, as UK retail and bank stocks rebounded.
“If the Budget had been more fiscally conservative, you would have expected gilts to rally more and stocks to sell off,” said Liam O’Donnell, fixed income manager at Artemis .
The Institute for Fiscal Studies said Britain would borrow an average of 85 billion pounds a year over the next four years, up from 59 billion pounds in pre-election plans.
But whether the benefits of additional public investment will outweigh the costs is a “gamble”, the economic research firm added.
Mr Reeves confirmed that government debt would now be measured against a broader definition of the public sector balance sheet, known as public sector net financial liabilities, which includes additional assets that can be offset through additional borrowing, in order to stimulate investment.
Borrowing plans released alongside the budget took debt issuance this year to 296.9 billion pounds ($385.61 billion), up from previous estimates of 277.7 billion pounds.
Those figures are largely in line with Reuters’ poll of primary dealers released this week, but gilt yields reversed their earlier fall and briefly rose, with some investors citing increased sales of longer-term bonds term.
In addition to changing the definition of debt, which markets had been expecting, the government said its debt reduction rule would ultimately apply to the third year of its budget forecast. This contrasts with the previous government’s rule, which was a fifth-year rolling target, meaning debt reduction plans were repeatedly pushed back.
“Mr Reeves has done a reasonable job of building credibility with the gilt market,” said Marlborough fixed income manager James Athey, who added that he was positive on the gilt’s debt. British government and that bond markets would welcome the increased revenue from tax rises.
Tom Williams, head of trading and structuring solutions at Schroders, said he sees enough demand from pension plans, banks and wealth managers to buy this year’s debt sales “in a manner ordered”.
A BOOST TO THE FTSE
Analysts also noted that the budget is unlikely to change the outlook for the Bank of England, which is expected to cut rates at its meeting next week. Nonetheless, markets have slightly reduced the odds of a November cut and now see less than a 50% chance of a December cut.
Jason Da Silva, director of global investment strategy at Arbuthnot Latham, said low UK consumer confidence could also improve thanks to Labor’s promises to increase healthcare and investment spending.
“This should be beneficial for UK-focused stocks, given they are already cheap,” he said.
With UK stocks long depressed by concerns over public finances and political instability, the broad FTSE All-share index trades at a discount of almost 40% to its global peers.
“I have been overweight UK domestic stocks and smaller companies over the last year, seeing them as beneficiaries of a healthy UK economic recovery,” said Hugh Sergeant, head of value and takeover within the investment company River Global.
“They have been weak recently, due to nervousness ahead of the budget. They have recovered today and I expect them to continue to be strong.”
