Oliver Faizallah, Head of Fixed Income Research at Charles Stanley, part of Raymond James Wealth Management, comments: “Markets are concerned about the UK’s fiscal position, and rightfully so. There isn’t an easy solution to the high levels of debt to GDP and growing deficit, and this is reflected in very elevated gilt yields.
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“Yields will likely remain elevated until we get a clear plan at the Autumn Budget, though given the UK government’s promises not to increase austerity and to keep its fiscal maths in order, the Autumn budget will inevitably bring higher taxes. This isn’t a quick fix though. Higher taxes may create a fiscal doom loop, where tax increases hurt demand and growth, further lowering tax receipts.
“It’s our view that risks are priced into gilt markets. We believe that elevated yields are a product of a structural shift in supply and demand. For decades, the UK could rely on demand from defined-benefit pension funds looking to match their liabilities with long-dated gilts. Yet their purchases have been dissipating at the same time as the Bank of England which accumulated close to £1 trillion of gilts through its quantitative-easing program, has been selling down its holdings, and increasing the supply of bonds whilst the government also seeks to borrow more.
“In addition to the Chancellor committing fiscal rules on borrowing, the BoE’s reduction of long end bond sales, and the DMO’s plan to reduce long end bond issuance, should go some way to dampening the long end sell off.
“Risks to gilts come in the form of a breaking of the fiscal rules and increasing government spending funded by further gilt issuance. In which case we may see the bond market fight back. Given recent market reactions and the not-so-distant memories of the Truss-Kwarteng budget, we see this is as unlikely.”
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