Bond traders brace for Budget borrowing bonanza
City investors and bond traders are bracing for the fallout of Labour’s first Budget in 14 years tomorrow as the new government looks set to hike taxes and ramp up borrowing.
Ahead of the Budget, the interest rate on government debt has crept up while investors and entrepreneurs have warned of the damaging impacts of a tax raid.
Chancellor Rachel Reeves confirmed last week that she will reform the fiscal rules to allow for tens of billions of extra borrowing over the course of the parliament.
She will shift the debt target to public sector net financial liabilities (PSNFL), which will increase her headroom by around £50bn.
Although Reeves is likely to limit the initial increase in investment to £20bn – roughly enough to stave off previously planned cuts – this will still require borrowing to rise.
According to analysis from the Financial Times, investment banks expect gilt sales to total £300bn this year, up from a previous figure of £278bn.
This would be the second-highest figure on record, behind only the pandemic. Reflecting this likely increase, gilt yields have steadily crept up in the weeks leading up to the Budget.
The yield on the benchmark 10-year gilt stands at around 4.28 per cent, up from 4.07 last Monday and 3.70 in mid-September.
Rupert Thompson, chief economist at IBOSS, said some of this was due to Budget “skittishness”, although he suggested the “greater part” was due to markets repricing the path of interest rates in the US.
And despite the likely increase in gilt issuance, bond investors were not anticipating a big market reaction in response to the Budget.
“The newly elected Labour government has gone out of its way to reassure investors of its fiscal prudence,” Joe Maher, assistant economist at Capital Economics said.
However, analysts at UBS warned changes to the fiscal rules could trigger some nervousness in corners of the market and weigh on demand for government debt in the short term.
“The cautious or cynical would emphasise the rules as a guardrail against excess spending into economic downturn or to bolster the economy into the end of an electoral cycle,” UBS analysts, Anna Titareva and Emmanouil Karimalis, said in a note.
“But even if justified as funding for well-chosen and executed investments that reinforce the UK’s long-term debt capacity, demand for gilts might not recognise that immediately.”
Reeves has pledged a “new settlement” on Wednesday to “rebuild” the country and “seize the massive opportunities in technology and energy that are out there”.
“There is a global race on for those jobs and we need to seize them for Britain. If we can unlock that investment, public and private, then we can do great things as a country again,” she told the Observer on Sunday.
Taking AIM
However, the government has been rocked by an avalanche of warnings that Reeves’ rumoured tax plans could choke off inmvestment by the private sector and erode the appeal of Britain as a place to run a business.
Investors are expecting the government to lift capital gains tax and tweak the inheritance tax regime, in a move which some fear could involve scrapping the reliefs carved out for shares on London’s junior AIM market.
Under current rules, shares on the market qualify for business property relief, meaning they are exempt from inheritance tax if they have been held for more than two years.
Reeves has been told to scrap the exemption at the Budget in a move which could raise around £1.1bn for the Treasury, according to the Institute for Fiscal Studies.
However, such a move could also suck around £6bn from the market and cause shares to dive some 30 per cent, investment bank Peel Hunt has warned.
Mid-cap brokers have been alarmed by the suggestions after a flood of firms have exited the junior bourse in the past two years. AIM has shrunk to its smallest size in 23 years after a flurry of takeovers and delistings since the start of 2023, according to London Stock Exchange figures.
Julian Morse, co-chief of Cavendish, the City broking house and investment bank, told Morning Wire today it was “paramount” that investors were now incentivised to back AIM stocks.
“If the Chancellor scraps IHT relief on AIM shares, this would go totally against the government’s growth agenda,” he added.
The boss of the London Stock Exchange, Julia Hoggett, has also waded into the debate and wrote to the City minister warning that scrapping the relief could threaten the “viability” of the market.