UK chancellor Rachel Reeves must deliver a Budget this week that cuts spending and raises money without fuelling inflation, according to fund managers responsible for trillions of dollars of investors’ cash.
The gilt market has suffered a choppy year in which worries about inflation and the amount of bond issuance have helped send long-term borrowing costs to their highest level since 1998 over the summer. A U-turn this month on a plan to raise income tax sparked a sell-off, in a sign of the market’s nervousness.
Investors at some of the world’s biggest bond fund management firms told the Financial Times how they think the Treasury could land a Budget that reassures investors by increasing the government’s headroom against its self-imposed borrowing limits.
Roger Hallam, global head of rates at Vanguard
“[The government] must demonstrate a firm commitment to its fiscal rules. We expect a mix of higher taxes, in addition to modest spending cuts, will be used to restore and expand fiscal headroom to around £15bn. This is the minimum anticipated by market participants and failure to deliver it would likely result in higher gilt yields.
“The Budget also presents an opportunity to take targeted action to reduce inflation, for example, by reducing levies on energy bills. This could trigger a virtuous cycle: lower inflation, more BoE rate cuts supporting growth offsetting some of the fiscal drag, lower gilt yields and therefore reduced debt-servicing costs, ultimately strengthening the UK’s fiscal position.”
Kim Crawford, global rates portfolio manager at JPMorgan Asset Management
“We would like to see discipline in reaffirming current fiscal rules, alongside a commitment to fiscal consolidation that creates a larger cushion against future shocks. It is crucial that this is carefully funded by measures that avoid fuelling inflation.
“This should help keep borrowing costs down and support overall bond market stability. Looking beyond this year, a credible approach to reforming spending would further strengthen confidence in UK public finances and reinforce investors’ appetite for UK government bonds.”
Vincent Mortier, group CIO at Amundi
“Giving lessons on a Budget exercise might sound awkward coming from a French person, but if the chancellor convincingly fills the fiscal hole commensurate with a growth outlook based on a realistic productivity growth projection by the OBR — unlike last year — then markets should be convinced that she will not need to come back with more measures in six months’ time.
“No Budget measure on November 26 should put upward pressure on near-term inflation, and the bond market will react badly if the BoE cannot resume rate cuts over the next six months. Reforms and deregulation have to speed up to put growth on a higher trajectory, the only feasible way out of the UK’s high debt burden.”
Andrew Law, chair and chief executive of Caxton Associates
“The gilt market is most concerned that any fiscal tightening does not hurt growth. [Tax rises] can’t hurt business and can’t hurt inflation. Freezing the thresholds is an obvious one. Taking away some of the higher-rate pension privileges is another one, and amending some of the council tax bands where people in London pay lower council tax on £1mn homes than people in Scunthorpe.
“As of today, we’re squarely in a doom loop [of tax rises and low growth]. If the Budget does the right things we can escape out of the doom loop. If Reeves clears the air in terms of no more tax rises around the corner, and the household sector starts to spend and the bank rate comes down . . . we could easily go into the Budget in a year’s time with headroom of £60bn-£70bn.”
Mike Riddell, fund manager at Fidelity International
“A Budget that is good for the gilt market is not necessarily good for the UK economy. But a Budget that’s bad for gilts would see borrowing costs soar, and is definitely bad for the economy. Since the summer, gilt investors have been rejoicing over noises about tax increases and spending cuts.
“This combination should dampen growth and lower inflation, and give the green light for the Bank of England to cut rates in December. The government’s tougher challenge is to deliver a budget that also manages to boost UK productivity, because without investment there is no growth, and without growth the UK has a big problem.”
Bill Campbell, portfolio manager at DoubleLine
“The exclusion of an income tax increase in the Budget preparations last week was clearly disappointing. Now I am focused on the credibility of the total package to be presented. I had hoped to see meaningful measures such as revenue increases [tax raises] and spending cuts, but that picture has become much less clear.
“It appears that chancellor Reeves will attempt to thread the needle to do just enough to satisfy the market. Such a strategy would risk discrediting the government as serious custodian of the Budget issues, making these only more difficult to address in the future.”
Mark Dowding, chief investment officer for fixed income at RBC BlueBay Asset Management
“Higher taxes are not needed in the upcoming Budget. In an economy like the UK, which already has a historically high tax burden, raising taxes won’t translate into material revenue gains, as this impairs growth and deters wealth creation. What the bond market would rather see is more action to tackle runaway welfare spending.
“Furthermore, it is possible to enact measures that save the Exchequer money and stimulate growth. The UK pays far too much for its energy, is missing out on oil and gas tax revenues and is impairing housebuilding, all as a result of overly ambitious net zero timelines.”
Greg Peters, co-chief investment officer for fixed income at PGIM
“The forthcoming Budget is set to arrive amid market volatility, uncertainty, and fragility, after a surprise U-turn on tax rises caused investors to lose confidence that the government was going to deliver decisive consolidation. This is against a backdrop of cooling yet elevated inflation, patchy economic growth, and higher interest rates.
“Headroom is crucial. Any credible plan must also include spending cuts. The government finds itself in an intractable position walking a tightrope, and as we have seen, even suggestions of an incremental or unbalanced approach will ignite debt sustainability concerns.”
Andy Chorlton, chief investment officer for fixed income at M&G Investments
“If the government maintains fiscal discipline alongside a tight monetary environment from the Bank of England, the UK economy could be on a stronger footing over the long-term.
“However, over the shorter term, with neither fiscal nor monetary flexibility, growth could stay subdued and inflation follow a downward trajectory. In that scenario, the UK may start to resemble Europe, with the prospect of Bank of England interest rate cuts priced into the medium and longer term. That could see yields head towards European levels, making gilts a buy here.”
Peder Beck-Friis, senior vice-president and economist at Pimco
“The Budget will be important for both fiscal credibility and the monetary policy outlook. After all the pre-Budget signalling, and gilt volatility, key uncertainties remain around the size of the fiscal buffer and the composition and timing of new measures.
“Bond markets will be hoping for more frontloaded tightening and a larger fiscal buffer to restore confidence. Political and fiscal uncertainties will likely persist . . . but if the government avoids inflationary taxes and follows through on its planned tightening, the fiscal backdrop will likely add pressure on the BoE to be the shock absorber and continue cutting rates.”
Adam Marden, senior fixed income manager at T Rowe Price
“Politicians across the political spectrum remain acutely aware of the influence the bond market has on their perceived credibility, following the ‘mini’ Budget fallout in 2022.
“Confronted with a productivity downgrade, elevated debt levels and few avenues to cut public spending, gilt investors will be looking to significant tax rises as a means to not only re-establish fiscal credibility, but to achieve sufficient headroom such that the Treasury can set policy for the medium term, without continuously navigating speculation over breaching their fiscal rules.”
Chris Jeffery, head of macro strategy at L&G’s asset management arm
“A well-functioning bond market is important for any government to fund and deliver its investment plans. Fiscal transparency and supply predictability in particular are necessary for any bond market to provide the associated financing at the lowest cost to the public purse.
“We do not believe that the UK is a big fiscal outlier relative to peers elsewhere in the OECD, but it will be important to demonstrate resolution to recommit to consolidation goals. The gilt market is likely to welcome any adjustment which credibly brings the deficit on the current Budget back into balance by 2029-30.”
Additional reporting by Costas Mourselas