Investors have warned Britain’s Chancellor Kwasi Kwarteng that the bonanza of tax cuts and spending measures he announced on Friday risks eroding their confidence in the country.
On Friday, the Chancellor heralded a “new era” for the UK economy, in which he plans to boost growth with the biggest tax cut since 1972 while protecting households from sky-high energy prices.
But after a sharp sell-off in markets in response, a number of investors have criticized the plans.
“There is a real risk that international investors will lose confidence in the UK government and this is causing a run on sterling,” said Mark Dowding, chief investment officer at BlueBay Asset Management. “The market asks, ‘How are you going to pay for this?’ . . . One almost gets the feeling that not the slightest attention has been paid to this question.”
Craig Inches, Head of Rates and Cash at Royal London Asset Management, said if the Chancellor’s plan failed to stimulate the economy, the UK could “potentially face a credit downgrade”.
Quentin Fitzsimmons, portfolio manager at T Rowe Price, added that the UK government’s strategy is to “go all out” and leave gilts and sterling as “victims”.
“The true cost of this massive borrow-to-spend binge is likely high. Possibly very high,” he warned. “As the old saying goes, ‘credibility takes forever to gain, but credibility can be lost quickly’ . . . Sterling and the gilt market have very long memories.”
The Chancellor’s announcement triggered turbulence on the financial markets. Long-dated gilts had their worst day since the 1990s as investors expected the government to pay significantly higher borrowing costs to raise an additional £62bn from bond investors by April as the pound’s recent slide deepened.
Two-year gilts were hit the hardest by Friday’s sell-off, with yields rising 0.63 percentage points to 3.8 percent. The Debt Management Office said the additional borrowing, which takes Gilts’ total turnover to £193.9 billion for FY2022-23, would be focused on shorter-dated bonds.
But longer-term yields also jumped, with 10-year borrowing costs hitting 3.8 percent, the highest since 2011.
Adding pressure on gilts came Thursday’s announcement by the Bank of England that it will begin shrinking its balance sheet next month by selling off bonds it bought under previous stimulus plans, starting with 8% of gilt sales £.7 billion in the last quarter of 2022.
“As the BoE moves from being a buyer to a seller of gilts and becoming increasingly unlikely to be a buyer again in the future, this will be a test of whether retail investors can absorb a large amount of issuance,” said Leiterin Daniela Russell of UK rates strategy at HSBC.
UK central bankers are already struggling to rein in inflation with a series of rate hikes, and following Kwarteng’s announcement, markets are betting that the BoE would need to raise borrowing costs even faster to offset the inflationary impact of its stimulus.
Inches said the BoE is in a “vicious feedback loop”.
“The bank almost has to be cruel to be kind. They have a big credibility problem right now,” he said.
The prospect of higher borrowing costs failed to lure investors into the sterling market, with the pound falling below $1.09 for the first time since 1985 on Friday. The pound sterling also fell 1.9 percent against the euro.
Analysts say the extra borrowing will put further pressure on the UK’s current account deficit, which widened to a record 8.3 percent of gross domestic product in the first quarter of 2022 – leaving London dependent on international investors to ease its increased debt issuance finance.
“Put simply, it’s American and European retirees who need to buy the additional issuance of gilts,” said George Saravelos, global head of FX research at Deutsche Bank.
“But in an environment of such high global uncertainty, we worry that the price foreigners will demand in exchange for funding the new stimulus will be very high. In other words, the equilibrium value of gilts, expressed in terms of dollars and euros, must fall sharply.”
Additional reporting from Nikou Asgari and Madison Darbyshire