(Bloomberg) -- UK traders are looking to the Labour government’s first budget in almost 15 years to convince investors that Britain is once again a safe destination for their cash.
Listen to the Bloomberg Daybreak Europe podcast on Apple, Spotify or anywhere you listen.
Gilts jumped sharply on Wednesday, lowering the 10-year yield by 10 basis points to 4.22%. The bonds were by far the biggest gainers across major markets, a sign some investors were unwinding their short bets before the event. Sterling fell while the benchmark stock index was down 0.25%.
Investors are “positioning for a gilt bullish outcome,” said Megum Muhic, a strategist at RBC.
UK assets went on a tear in the wake of July’s election, with the pound rising to a two-year high and British stocks hovering near a record. But those gains have dimmed in recent weeks as the budget neared, with gilts having their worst month since April.
It’s a crucial moment for the new administration, which has sought to link unpopular tax hikes and spending cuts to previous governments’ decisions — in particular, former premier Liz Truss’s botched mini-budget of 2022, which sent bond yields rocketing. Investors are looking for Chancellor Rachel Reeves to demonstrate a tight grip on the nation’s purse strings when she presents her budget starting around 12:30 p.m. in Parliament, yet foster growth at the same time.
“The new Chancellor faces a delicate balancing act by having to convince markets that increased borrowing for infrastructure investment won’t compromise fiscal stability,” said Adam Singleton, chief investment officer of external alpha solutions at Man Group. “The success of Labour’s economic program — and perhaps its political future — depends entirely on whether markets trust Reeves to stick to her promises while delivering on the party’s vision of economic renewal.”
Reeves is due to announce around £35 billion ($45 billion) a year in tax and welfare savings, alongside a fiscal-rules revamp that will enable an extra £70 billion of government borrowing for investment.
Reeves to Raise Taxes to ‘Rebuild’ UK in High-Wire First Budget
Here’s what markets are watching:
Bonds
Before Wednesday’s rally, the possibility of increased gilt issuance had helped drive the 10-year yield toward its highest levels of 2024.
Yields on shorter gilt maturities have risen more relative to longer-dated ones in anticipation that the Debt Management Office will continue to skew issuance toward shorter-dated debt. That’s lowered the spread between five- and 30-year borrowing costs for a seventh day — the longest streak since 2022 — to a four-month low at 59 basis points.
Any aggressive surprises in the spending plans and there could be “a less favorable reaction,” said Huw Davies, who manages a strategic absolute return bond fund at Jupiter Asset Management.
At the same time, renewed pledges to keep a tight grip on the nation’s purse strings should reassure markets and enable the Bank of England to continue cutting interest rates, said Peder Beck-Friis, an economist at PIMCO.
“We expect the budget to maintain a tight fiscal path ahead, with the deficit continuing to decline,” he said. “As the market shifts its focus from looser fiscal rules to a declining deficit, easing inflation, and softening labour market conditions, we expect some lingering risk premium in the gilt curve to fade over time.”
Stocks
Moves in gilt yields could ripple through to property-sector stocks like Barratt Redrow Plc and The British Land Co. Plc, as well as utilities like British Gas-owner Centrica Plc. Banks, such as Lloyds Banking Group Plc, are sensitive to yields due to their impact on lending margins.
Pound movements, meanwhile, will have implications for the FTSE 100, with more than three quarters of the index’s revenue coming from outside of Britain.
UK Equity Investors Brace for Reeves’ First Budget: Taking Stock
Stock pickers will be looking to see where the budget cash gets doled out. London-listed shares have been trading near all-time highs, boosted by easing monetary policy as well as by optimism that the government will crank up investment in homes, roads, and other public infrastructure.
Steps to address the perceived inequality between high street and online firms could hit retail shares, including Associated British Foods Plc owned Primark, Boohoo Group Plc, and other retail-exposed estate firms like Land Securities Group Plc.
And more generally, broad changes to taxes affecting capital gains, pensions and inheritance could impact the overall appetite for investing in UK shares.
The Pound
Strategists expect the pound will continue to find support if there’s evidence additional capital investment will boost growth. Currency traders will be watching for updated growth forecasts due from the Office of Budget Responsibility.
“If GDP is revised higher for the long term, and if debt levels under the new public sector net financial liabilities measurement remain stable over the long term, then the pound could recover back above $1.30,” said Kathleen Brooks, research director at XTB.
At the same time, options markets are pointing to the risk that FX trading could get volatile after the announcement, and knock the pound towards $1.29. The cost to hedge against pound swings versus the dollar rose to its third-highest level of the month on Wednesday.
--With assistance from Joshua Gaunt-Warner, Alice Gledhill, Vassilis Karamanis, James Hirai and Greg Ritchie.
(Updates prices, adds analyst voice in third paragraph.)
©2024 Bloomberg L.P.