(Bloomberg) -- The gilt market faces the risk of a “buyers’ strike” if UK Chancellor Rachel Reeves borrows tens of billions more for investment, according to a Citigroup Inc. economist.
Ben Nabarro, chief UK economist at the US-based bank, said Britain would be less able to “flood the reactor and really contain that risk” than other economies given its reliance on foreign buyers for its debt.
His comments come amid expectations that Reeves will announce new debt rules at the budget on Oct. 30 to allow more spending on investment. One option would hand the chancellor an extra £53 billion ($69.3 billion) of borrowing capacity, raising fears among gilt investors that have limited appetite for new bonds. UK yields are at their highest for over a year relative to their German peers.
Nabarro spoke in a briefing to launch the Green Budget, a pre-budget analysis produced by the Institute for Fiscal Studies in collaboration with Citi.
Reeves is facing a tricky fiscal backdrop as she tries to find more money to plug a budget black hole and revive public services without spooking investors.
Current fiscal rules requiring underlying debt to be falling as a share of GDP in five years give just £8.9 billion of headroom, the Office for Budget Responsibility said in March. An alternative measure thought to be under consideration — public sector net financial liabilities — provides a margin of £62 billion.
Reeves has signaled she wants to end the clampdown on investment spending planned by the previous Conservative government and spur economic growth.
Investors are already being asked to absorb £138 billion of new gilts from the Treasury to fund the budget deficit in the current fiscal year, plus many billions more as the Bank of England unwinds its vast quantitative-easing program. It amounts to the second-largest supply on record.
“[It’s a] material concern, but not now,” Nabarro said of the risk of a buyers’ strike. “If the rules are changed and the possibility is entertained that Rachel Reeves could invest something like £50 billion next year, then I think it’s a conceivable risk.”
Economists including Nabarro don’t expect Reeves to increase borrowing on such a scale. Investment should be “scaled up slowly,” he added.
UK bond yield premiums rose to their highest in more than a year against US and German peers this month. Laurence Mutkin, head of EMEA rates strategy at Bank of Montreal, believes Reeves’s commitment to fiscal discipline is in doubt.
But rate strategists at Citigroup and Toronto Dominion Bank make the case that fiscal concerns are now overdone. They both recommend buying gilts and respectively selling Treasuries and bunds ahead of the budget.
Nabarro said that the UK is “running a more material liquidity risk” than other major economies, putting it under tighter fiscal constraints than the US and eurozone.
“The UK has to attract foreign buyers into its gilt market and what that means is it’s more conceivable that a certain quantity of demand for the gilt market or for UK sovereign debt can disappear,” he said.
The comments came as the IFS laid bare the challenge facing the chancellor as she tries to steady the ship after a rocky start for the new Labour administration.
The research firm said that Reeves will need to increase spending by £30 billion to meet her pledge not to reimpose austerity on struggling public services.
It calculated that day-to-day spending will need to be topped up by £14 billion in 2028-29 just to pay for announced public-sector pay hikes and Labour’s manifesto pledges. She would need to find an extra £16 billion to avoid making real-terms cuts to spending on any public services.
Meanwhile, taxes may have to rise by £25 billion if Reeves wants to deliver real improvements to services without breaking a commitment to pay for day-to-day spending out of tax revenue.
A Treasury spokesperson said: “It’s right to say that we have inherited a tough financial position, but we won’t let the challenges of the past define our future.”
“Despite uncovering a £22 billion black hole in our public finances we are focused on making this the most pro-growth Treasury in history, built on the rock of economic stability, including robust fiscal rules that were set out in the manifesto. That is how we will fix our public services and deliver on the promise of change.”
The IFS cautioned the chancellor against targeting a public sector net worth rule that tries to measure assets as well as liabilities.
“We have particular concerns about using public sector net worth as a fiscal target,” said Carl Emmerson, deputy director of the IFS. “It’s very hard to measure the value of the prison estate or the road network and changes in that valuation don’t really tell us much about the health of the public finances.”
--With assistance from James Hirai.
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