Fund managers say that a new Labour government can raise additional money from the bond market for investments without creating a Liz Truss style gilts crisis.
If Labour wins the 4th of July election, the Shadow Chancellor Rachel Reeves will keep the Conservative government’s promise that the debt as a percentage of GDP should be falling in five years.
She also reneged on an earlier promise to invest £28bn per year in green investments, as she tries to emphasize Labour’s commitment towards fiscal responsibility.
Bond investors, however, said that the market would be tolerant if the new government increased borrowing and amended its debt rules as long as the funds were used to stimulate the economic growth.
Tom Roderick is a portfolio manager with hedge fund Trium Capital. He said that markets won’t worry if Labour borrows for investment. “The markets are more concerned about borrowing to reduce taxes or increase social insurance payments, which does not sound likely.”
Labour has tried to assure markets that it won’t repeat the mistakes of Liz Truss, former UK prime minister in her 2022 “mini-budget. A package of £45bn unfunded tax reductions triggered a rush on the pound as well as a spike of borrowing costs for UK government.
Reeves said in an interview that Labour will focus on growth of the economy, as it is “the only solution to this mess”, and he was referring to high tax revenue and borrowing.
Reeves said that “borrowing more money is not an option because the debt as a percentage of the GDP is at its highest level since the 1960s”. He added that “taxing more” was “not an option because the tax rate is already the highest in 70 years”.
Investors expect Reeves will stick to his current plans to issue net gilt of £216bn during the current financial period, which is the highest ever adjusted for Bank of England purchases and sales.
Her fiscal conservatism has allowed the gilt market to be relatively calm in the run-up to the elections, compared to the turmoil that was sparked in France by the prospect a far right government.
Sterling is the only developed market currency that has held its value this year against a rising US dollar.
Investors say that modest borrowing increases are possible in 2025.
Would it be out of control if the UK borrowed a bit more? Ales Koutny is the head of Vanguard’s international rates. He said that it was not a problem. He added that since the Truss-induced turmoil subsided, “markets are quite agnostic” about high deficits.
Investors might also be more accepting of a relaxation in fiscal rules than Reeves implies. Some fund managers and economists have suggested that Labour could change its definition of net credit to exclude losses from the BoE bond portfolio.
Simon Ward, a Janus Henderson adviser, says that there is room to change the framework in order to allow for more borrowing, as long as the Office for Budget Responsibility, a fiscal watchdog, enforces updated rules.
Tomasz Weiladek, T Rowe Price’s chief European economist, says that Labour could “probably add” “£20bn to £30bn “to the gilt remit, without increasing borrowing costs.
Investors’ willingness to accept a change in the self-imposed borrowing restrictions echoes recent remarks made by Andy Haldane who was the former chief economist of the BoE. He said, “existing fiscal regulations risk starving an economy of investment that is needed to boost growth on a medium-term basis.”
As the BoE finishes its fight with inflation, which has now returned to the central banks’ 2 per cent target after three years, the prospect of lower interest rates could give the next government more flexibility.
Matthew Amis is a portfolio manager for Abrdn. He said that the Labour Party should hope that, by November 2025 the inflation will be under control, that the BoE has already begun their cutting cycle, and that the US and Europe won’t have spooked markets. This would create an “environment where Reeves could explore expanding out the fiscal rules”.
Some investors believe that the shadow chancellor must be careful when testing the appetite of the gilt market for additional issuance, given the explosive response to Truss’s borrowing plans in 2020.
Craig Inches said Reeves had a reputation for being “a safe pair” of hands, thanks to her previous experience as an economist at the BoE.
He said that it was unlikely that Trussonomics would be a factor in her decision to do so.
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