Reeves should be ‘thankful’ for avoiding Truss-style market crisis, analysts say
Rachel Reeves should be “thankful” for avoiding the same fate as Liz Truss after the government’s inaugural Budget triggered turmoil in the gilt market last week, analysts have said.
In the days after the Chancellor laid out her fiscal plans on Wednesday, bond traders took fright at a £30bn increase in borrowing per year, alongside a £40bn tax raid primarily targeted at businesses and the wealthy.
Reeves has claimed she was left with little choice after inheriting a £22bn “black hole” in the public finances from the previous government.
However, markets were shaken by the scale of the borrowing, pushing yields on 10 year gilts – seen as an indicator of government borrowing costs – to a 13 month high of 4.48 per cent on Friday morning.
The scale of the swing caused some City analysts to question whether the Chancellor would face a similar crisis to Liz Truss, whose uncosted tax cuts sent shockwaves through the gilt market in 2022 and helped topple her premiership.
However, Reeves was able to avoid the same fate due greater visibility of debt fuelled investment strategies used by pension schemes, analysts at Bloomberg Intelligence (BI) said.
“Rachel Reeves should be thankful for the absence of lurking leverage issues that helped bring down Liz Truss,” Huw Worthington, a rates strategist at BI, said in a note today.
Truss’s disastrous mini-budget sparked a crisis in the UK’s pension system when a slide in gilt prices triggered a series of hefty cash calls for money managers using ‘liability driven investment’ strategies.
Such strategies were highly vulnerable to moves in the price of government bonds. The Bank of England was eventually forced to step in with an emergency bond buying programme to shore up the market.
Analysts at Peel Hunt played down the comparison, however, and said the scale and speed of the swings in 2022 far outstripped movements in the market last week, “suggesting the UK is not facing genuine worries about its fiscal credibility”.
The government’s spending plans have caused traders and economists to reassess the direction of interest rate cuts in the UK, however, after the Office for Budget Responsibility suggested a surge of government spending could fuel inflation in the next year.
The Bank of England is expected to lower interest rates this week but markets are betting on fewer cuts next year on the back of a potential rise in inflation.
Economists surveyed by Morning Wire this weekend predicted fewer than four quarter-point cuts next year, compared to almost five before the Autumn Statement.
“Those worries over the inflationary impact of inflationary policies in the Budget have been laid bare in market pricing of where [Bank of England] policy rates are likely to end up,” Worthington added.
“Markets now expect rates to fall to a low of just four per cent from what was expected to be sub- three per cent in September, and then stay around that level or even rise thereafter.”