The economist says: “The rapid growth in (nominal) spending has led to weak household saving, even though the government has been ‘topping up’ household resources by itself running a large deficit. Indeed the UK government routinely borrows more than the population saves.”
Changing times
He says QE enabled this to happen, but this may no longer be the case, and he says it may be that the UK will unable to borrow significantly more, regardless of which party is in power.
Hunt says in such a scenario the UK government will have to tighten fiscal policy, either to drive up savings rates (as UK individuals may be reluctant to place capital into riskier assets if government spending is being cut), and to reassure overseas buyers about the direction of the UK deficit.
Michael Born, research analyst at Morningstar, says new chancellor Rachel Reeves has “hammered home their message of fiscal responsibility, cutting spending as well as likely raising taxes.”
He believes this will be positive for the price of gilts as it provides reassurance to markets after “several years of aggressive borrowing and spending, culminating in 2022’s mini Budget”, but says that the size of the UK’s ongoing budget deficit means “we are unlikely to see huge rallies” in the gilt price.
A budget deficit is the difference between the level of government income and government spending, funded by the issuance of gilts.
If the deficit remains, then gilts have to be issued in order to fund it, maintaining supply at a certain level, and potentially putting pressure on demand.
Mark Nash, a fixed income fund manager at Jupiter, is slightly more bullish on gilts, based on valuation.
He acknowledges the problems a persistent and large budget deficit represents for gilt prices, but says many other countries, such as France, also have large deficits and he regards the price of gilts as being cheaper than the price of bonds issued by those countries, which could be supportive of gilt prices, if investors are presented with a choice between gilts and more expensive developed market government bonds, with the same sort of economic fundamentals present in both countries.
Craig Inches, Royal London Asset Management’s head of rates and cash differs from Harris in his view that if inflation, interest rates and bond yields do remain higher than many market participants presently expect, the likely outcome is that investors would want a higher yield to own bonds longer, this is known in markets as “term premium”, as he expects declining base rates to predominantly impact the shorter end of the yield curve.
