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TWITCHY, TRUSS-SCARRED UK BOND MARKET AWAITS A LABOUR GOVERNMENT

By Harry Robertson
July 5, 20249:33 AM GMT+2Updated 12 days ago
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British opposition Labour Party leader Keir Starmer speaks to the media during a
Labour general election campaign event, in Norton Canes, Britain July 2, 2024.
REUTERS/Claudia Greco/File Photo Purchase Licensing Rights, opens new tab
LONDON, July 3 (Reuters) - A bond market crisis that rocked Britain's economy
two years ago has cast a long shadow over the country's July 4 election which
will likely linger as a new government finds its feet.
Spooked by plans by the ruling Conservative Party's then-Prime Minister Liz
Truss to slash taxes in September 2022, the scars of the bond rout remain.
Politicians have avoided grand economic plans in the current election campaign
for fear of waking the bond market dragon. The opposition Labour party has used
the episode, which also pushed sterling to record lows and jacked up mortgage
rates, to attack the Conservatives' economic record.
Advertisement · Scroll to continue

Labour, well ahead in the polls, looks set to inherit one of the highest debt
loads in UK history. Yet looming interest rate cuts could work in its favour.
The following five charts outline the sort of bond market awaiting the next
government:


1) STILL-HIGH BORROWING COSTS

After the 2022 mini-budget crisis, Britain's 10-year bond yields soared to a
14-year high on fears about high levels of borrowing and as complicated pension
fund investment strategies were caught in the meltdown. Yields rise as prices
fall.
Advertisement · Scroll to continue

The Bank of England stepped in to stabilise markets, yet 10-year gilt yields
remain well above those in benchmark euro zone bond issuer Germany . That's
largely because stickier UK inflation forced the BoE to hike rates to 5.25%,
compared with 4% in the euro zone.
Yet there is some reason for optimism. Barclays analysts reckon the
"idiosyncratic risks around gilts seem much less than in other markets", as the
rise of the far right rocks France and unsettles Europe.


Reuters Graphics


2) BRITAIN TESTS THE MARKET

Britain's borrowing needs, exacerbated by the COVID-19 crisis and the Ukraine
war that sent energy prices soaring, remain high.
The 2024-25 financial year is set to be the second-highest for government debt
issuance on record at 278 billion pounds ($350 billion). Pressure is unlikely to
ease any time soon, even before new policies are considered.
Separately, the BoE is meanwhile cutting its bond holdings by 100 billion pounds
a year, including through active sales - meaning more pressure on the market to
soak up new debt and raising some concerns about financial stability.


Reuters Graphics


3) RATE CUTS ARE COMING

The good news for Labour's Rachel Reeves, set to become Britain's first female
finance minister, is that BoE rate cuts will likely start soon.
Inflation has slowed back to its 2% target amid tepid growth, and traders
anticipate a first cut in August or September. Money market pricing suggests
rates will fall by around 1.2 percentage points by the end of 2025.
"If you've got an economy that's slowing and interest rates are being cut ...
you generally don't have a problem selling sovereign bonds," said Craig Inches,
head of rates and cash at Royal London Asset Management.


Reuters Graphics


4) SOLID DEMAND

Demand for Britain's bond sales has been strong, with record bids for one issue
in March. Rate cut bets have made government bonds appealing - bond prices rise
as rates fall, as older, higher-yielding debt becomes more attractive than new
issuance.
Prospects for stability after a period of political and economic uncertainty has
also boosted sentiment towards UK assets.
Yet Royal London's Inches said inflation may pick up in the coming years and
rates could rise again.
"That type of environment, where you've got very high levels of supply in a
rate-rising environment, with poor debt-to-GDP ratios, that becomes
problematic," he said, adding that borrowing costs would have to rise.

Reuters Graphics


5) UNCERTAIN INTEREST COSTS

Britain's interest payments on its debt has surged along with inflation and
interest rates, hitting a post-war high, opens new tab of 111 billion pounds in
2022-23, or around 4.4% of gross domestic product.
One problem for the incoming government is that forecasts for the debt interest
bill have bounced around along with market rate expectations. Although rates are
expected to fall, how low they will go remains uncertain.
This means that interest spending "is likely to remain a major source of risk to
the fiscal outlook," Britain's budget watchdog said in March.

Reuters Graphics
($1 = 0.7914 pounds)

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Reporting by Harry Robertson; Editing by Dhara Ranasinghe and David Holmes

Our Standards: The Thomson Reuters Trust Principles., opens new tab

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