Investors have warned British Chancellor Kwasi Kwarteng that the windfall of tax cuts and spending measures he announced on Friday risk undermining their confidence in the country.
On Friday, the Chancellor announced a “new era” for Britain’s economy, in which he plans to spur growth by delivering the biggest tax cut since 1972 while protecting households from sky-high energy prices.
But after the market sold off in response, a series of investors criticized the plans.
“There is a real risk that international investors will lose faith in the UK government and this will lead to 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?’ . . . There is almost a sense in which this question has not been considered.
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 be to blame” for a downgrade in its rating. credit.
Quentin Fitzsimmons, portfolio manager at T Rowe Price, added that the UK government’s strategy was “to go bankrupt”, leaving gilts and the pound as “victims”.
“The true cost of this massive borrowing-to-spend binge is likely high. Could be very high,” he warned. “As the old saying goes, ‘it takes forever to gain credibility, which can also be lost in an instant’… The British pound and the gilt market have very long memories.
The Chancellor’s announcement triggered turbulence in the financial markets. Long-term gilts had their worst day since the 1990s, with investors predicting the government would have to pay significantly higher borrowing costs to raise an additional £62bn from bond investors by April, while the recent fall in sterling has worsened.
Two-year gilts were the hardest hit in Friday’s selloff, with yields up 0.63 percentage points to 3.8%. The Debt Management Office said the additional borrowing, which brings total gilt sales for the 2022-23 financial year to £193.9bn, would be concentrated in shorter-dated bonds.
But longer-term yields also jumped, with 10-year borrowing costs hitting their highest level since 2011 at 3.8%.
Adding to the pressure on gilts, the Bank of England announced on Thursday that it would begin the process of reducing its balance sheet next month by unloading bonds it had purchased under previous stimulus packages, starting by £8.7 billion in gilt sales in the last quarter of 2022.
“With the BoE turning from a buyer to a seller of gilts, and looking increasingly unlikely to be a buyer again in the future, this will be a test of whether private investors can absorb a large amount issues,” said Daniela Russell, head of UK rates strategy at HSBC.
UK central bankers are already struggling to rein in inflation with a series of interest rate hikes and after Kwarteng’s announcement markets bet the BoE would have to raise borrowing costs even faster to offset the effects inflationary of its stimulus.
Inches said the BoE was in a “vicious feedback loop.”
“The bank almost needs to be cruel to be nice. At the moment they have a big credibility problem,” he said.
The prospect of higher borrowing costs failed to attract investors to the sterling market, with the pound crashing below $1.09 for the first time since 1985 on Friday. The British pound also fell 1.9% against the euro.
Analysts say the extra borrowing will put further pressure on the UK’s current account deficit, which has widened to a record high 8.3% of gross domestic product in the first quarter of 2022 – leaving London dependent on international investors to finance its increased debt issuance.
“Put simply, it’s US and European pensioners who will have to buy the extra gilt issuance,” said George Saravelos, global head of foreign exchange research at Deutsche Bank.
“But in an environment of such high global uncertainty, we fear that the price that foreigners will demand in exchange for financing the new stimulus will be very high. In other words, the equilibrium value of gilts expressed in dollars and in euros will have to fall sharply.
Additional reporting by Nikou Asgari and Madison Darbyshire