Investors may be unnerved by expensive election promises, which could increase debt costs.
Rishi Sunak is embarking on a debt spree ahead of general elections , which will see Britain borrow £206bn in a record amount this year.
Nomura economists have predicted that the Government is likely to be forced to heavily rely on the financial markets in order to finance borrowings this year and the following as the Bank of England reverses the bond purchases made under its quantitative ease (QE) program.
George Buckley is an economist with Nomura. He estimated that private companies will be asked to borrow £206bn this year and £237bn the following year. This is a record-high.
Mr Buckley stated: “In the next two years, there will be more gilts for the market [to buy] than in the nine previous years [combined].
Experts warn that borrowing aggressively could lead to higher interest rates, as Labour and Tories try to win votes by promising to reduce taxes or to increase spending.
Imogen Bachra, an analyst with NatWest Markets, said: “The worst case scenario is the UK being unable to finance itself through the capital markets.”
“More than likely, we will see a rise in the gilt yields because the clearing price to absorb this entire supply is being pushed down and further. We’ll return to higher yield levels on the curve.”
The Government borrowed £435bn in two years at the height of pandemic. This was financed in part by the Bank of England , which increased quantitative easing and bought £450bn of gilts.
Banks are now selling some of their bonds to private investors such as pension funds and insurers. Savings banks, insurance companies, and pension funds also buy these bonds. This means that the government is becoming more dependent on financial markets.
Paul Johnson, Director of the Institute for Fiscal Studies said that both the Tories as well as Labour had stressed caution when it came to borrowing, and they were “committed at least a moderate degree of fiscal commonsense”.
He added that political pressures are mounting to increase spending in the NHS, prisons and defence, as well as childcare. This could result in more borrowings, which would create uncertainty for the markets.
Investors are more sensitive to the politicians’ plans to spend, and they may charge Exchequer a higher interest rate to borrow. This would put additional pressure on public finances.
According to official estimates, the government is already spending more on interest payments due to higher borrowing costs.
Jim Leaviss is a bond market expert at M&G Investments. He said that markets are nervous after Liz Truss’s disastrous mini budget for 2022. This caused a spike in borrowing costs.
He said: “The scarring on the market’s memories around what happened back then will make investors very interested in [government] expenditure plans.”
It ties the hands of both potential governments in terms of fiscal easing ahead of a presumed general elections in November.
Vivek Paul said that any costly election promises could be unnerving to investors.
As inflation in the UK falls and as we approach the general election, it is possible that major UK political parties will be more inclined to promise a looser fiscal policy. The more this happens, the higher the probability of bond vigilantes returning.
Mohamed El-Erian said that he was expecting “a year of volatility in yields” and a “tug-of-war” between high borrowing, which drives interest rates higher, and low economic growth, which keeps borrowing costs lower.
Michael Eakins is the chief investment officer of Phoenix, a savings and retirement company. He said: “2024 will likely see record debt issuance across the G3, i.e. the US, eurozone, and UK.
“When there’s a big increase in debt issuance in the world, it does indicate that gilt yields are higher.”
Treasury Insiders said that the debt issuance on the market shows the need to control borrowing.
“The best thing we can do to keep gilt rates down is to maintain a tight grip on the public finances. That’s what we are doing.” The source stated that, as the Chancellor has said, tax cuts will only be made if they are affordable and sensible.