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A new Labor government could raise extra money for investment in the bond markets without triggering a Liz Truss-style government bond crisis, according to fund managers.
Shadow Chancellor Rachel Reeves has pledged to deliver on the Conservative government’s commitment that debt as a share of GDP should be on track to fall within 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 emphasize Labour’s commitment to fiscal responsibility.
But bond investors said the market could be forgiving if a new government decided to boost lending and adjust debt rules, provided funds were channeled into measures to stimulate the economy.
“If Labor borrows to invest, the markets won’t worry about it,” said Tom Roderick, portfolio manager at hedge fund firm Trium Capital. “What markets are more concerned about is borrowing to cut taxes or increase Social Security benefits, which doesn’t sound very likely.”
The Labor Party has gone out of its way to reassure markets that it will avoid a repeat of former Prime Minister Liz Truss’s 2022 ‘mini’ Budget, when a £45 billion package of unfunded tax cuts made a run on the pound and caused a spike in British government borrowing. cost.
In an interview with the Financial Times, Reeves insisted that Labor would focus on growing the economy as “the only way out of this mess”, pointing to tax revenues and borrowing at multi-decade highs.
“Borrowing more is not an alternative because debt to GDP is the highest it has been since the 1960s,” Reeves said, adding that taxing more was also “not an alternative because taxes are already at a 70-year high.”
Investors broadly expect Reeves to stick to current plans for a net government bond issuance of £216 billion in the current financial year, the highest on record when adjusted for Bank of England sales and purchases.
With Labor holding a big lead in the opinion polls, its fiscal caution has helped the government bond market remain relatively calm ahead of the election, in contrast to the French debt turmoil fueled by the prospect of a far-right government .
Sterling is the only major developed market currency to hold its value against a rising dollar this year.
However, investors say there is room for a modest increase in lending in 2025.
“If Britain were to borrow just a little bit more, would it get out of hand? No,” said Ales Koutny, head of international rates at Vanguard. Since the Truss-induced turmoil subsided, “markets have been fairly agnostic to high deficits,” he added.
Investors could also be more tolerant of a loosening of fiscal rules than Reeves suggests. For example, some fund managers and economists suggest that Labor could adjust its definition of net debt to exclude losses on the BoE’s bond portfolio.
“There is scope to change the framework to allow more borrowing” as long as the updated rules are monitored by the Office for Budget Responsibility, the budget watchdog, said Simon Ward, an adviser at Janus Henderson.
Labor could “probably” add £20bn or £30bn to government bonds without driving up borrowing costs, says Tomasz Wieladek, chief economist at T Rowe Price.
Investors’ openness to a shift in self-imposed borrowing restrictions reflects recent comments from the BoE’s former chief economist, Andy Haldane, who said that “existing fiscal rules risk starving the economy of the very investments needed to sustain growth.” in the medium term’.
The prospect of rate cuts as the BoE completes its battle against inflation – which has returned to the central bank’s 2 percent target for the first time in three years – could also provide more room to maneuver for the next government.
“The Labor Party must hope that inflation is under control by November 2025, that the BoE is well into their austerity cycle and that the US and Europe have not spooked the markets,” said Matthew Amis, portfolio manager at Abrdn. this would “create an environment in which Reeves can explore loosening fiscal rules.”
Still, some investors believe the shadow chancellor should be cautious in testing the government bond market’s demand for additional issuance, given the explosive response to Truss’s 2022 borrowing plans.
Craig Inches, a 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 is unlikely she will want to jeopardize this so quickly as part of the reason Labor will have a landslide is due to the Trussonomics experiment,” he said.