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A new Labor government could raise more money to invest in bond markets without causing a Liz Truss-style tinsel crisis, according to fund managers.
Shadow chancellor Rachel Reeves has vowed to keep the Conservative government’s pledge that debt-to-GDP must be on track to fall in five years if Labor wins the July 4 election.
She has also abandoned an earlier pledge to spend £28 billion a year on green investment as she seeks to underline Labour’s commitment to fiscal responsibility.
But bond investors said the market could be lenient if the new government decides to increase borrowing and adjust its debt rules, provided the funds are channeled into measures to stimulate the economy.
“If Labor borrows for investment, the markets won’t care,” said Tom Roderick, portfolio manager at hedge fund firm Trium Capital. “What the markets are more worried about is borrowing to cut taxes or increase Social Security payments, which doesn’t sound that likely.”
Labor sought to reassure markets that it would avoid a repeat of former prime minister Liz Truss’s “mini” budget for 2022, when a package of unfunded £45bn of tax cuts sparked an attack on the pound and a surge in UK government borrowing. costs.
Speaking to the Financial Times, Reeves stressed that Labor would focus on growing the economy as “the only way out of this mess”, referring to tax collections and borrowing at multi-decade highs.
“More borrowing is not an option because debt as a share of GDP is the highest it has been since the 1960s,” Reeves said, adding that higher taxation is also “not an option because taxes are already at a 70-year high.”
Investors generally expect Reeves to stick to current plans for net issuance of £216bn of gold in the current financial year, a record high, after adjusting for Bank of England sales and purchases.
With Labor enjoying a commanding lead in opinion polls, its fiscal prudence has helped the gilt market remain relatively calm ahead of the election, unlike the turmoil in French debt sparked by the prospect of a far-right government.
Sterling is the only major developed market currency to hold its value against the rising dollar this year.
However, investors say there is room for a modest increase in borrowing in 2025.
“If the UK borrowed a bit more, would it get out of hand? No,” said Aleš Koutný, head of international rates at Vanguard. Since the Truss-induced shocks subsided, “markets have been pretty agnostic about high deficits,” he added.
Investors may also be more tolerant of fiscal loosening than Reeves suggests. For example, some fund managers and economists are suggesting Labor adjust its definition of net debt to exclude losses on the BoE’s bond portfolio.
Simon Ward, an adviser at Janus Henderson, which is overseeing the updated rules, said: “There is room to adjust the framework to allow more borrowing.”
Labor could “probably” add “£20bn or £30bn” to the gilt job without raising borrowing costs, said Tomasz Wieladek, chief European economist at T Rowe Price.
Investors’ openness to a shift in self-imposed borrowing restrictions echoes recent comments by former BoE chief economist Andy Haldane, who said “the existing fiscal rules risk starving the economy of the very investment needed to boost medium-term growth”.
The prospect of interest rate cuts once the BoE completes its fight against inflation – which has returned to the central bank’s two per cent target for the first time in three years – could also open up further room for maneuver for the next government.
“Labour has to hope that by November 2025 inflation is under control, the BoE is in a tapering cycle and the US and Europe haven’t spooked the markets,” said Matthew Amis, portfolio manager at Abrdn, adding that this would “create an environment where Reeves could explore the expansion of fiscal rules’.
Still, some investors believe the shadow chancellor should be cautious about testing the gilt market’s appetite for more issuance, given the explosive response to Truss plans to borrow in 2022.
Craig Inches, bond portfolio manager at Royal London Asset Management, said Reeves enjoyed a reputation as a “safe pair of hands” thanks to her experience as a former BoE economist.
“It’s unlikely he’ll want to jeopardize that so soon, given that one of the reasons Labor is getting a landslide is because of the Trussonomics experiment,” he said.