(Bloomberg) -- Struggling UK government bonds will bounce back after the Labour government’s first budget is out of the way at the end of this month, according to strategists at Goldman Sachs Group Inc.
Gilts have trailed peers in the past month on concern the government will ramp up debt supply and change rules that determine how much it can borrow. But that will change once Chancellor Rachel Reeves presents a budget that Goldman strategists expect will be “fairly gilt friendly.”
“Gilt underperformance won’t last,” wrote strategists including George Cole in a research note. They recommend bets on two-year and 30-year debt, saying the market will get an added boost from the prospect for more interest-rate cuts from the Bank of England.
Gilts have lost 3.4% in the past month, more than the 0.8% for European bonds and a 2.1% drop for US Treasuries, according to Bloomberg indices. The slide has continued despite BOE Governor Andrew Bailey saying the central bank could become a “bit more aggressive” and “a bit more activist” in its approach to cuts, in an interview published early this month.
While the Goldman strategists cited this “dovish pivot” to be bullish on two-year gilts — among the most sensitive to monetary policy changes — they suggest steering clear of 10-year bonds because any greater government borrowing is likely to be felt on that part of the curve.
The focus on borrowing levels comes two years after former Prime Minister Liz Truss’s plans for unfunded tax cuts sparked a gilt rout. Most analysts don’t expect a similar reaction this time, given spending would be for long term investment. Still, a Citigroup Inc. economist has warned the gilt market could face the risk of a “buyers’ strike.”
Goldman said in a separate report that the UK government is most likely to opt to change the debt rule to target headline rather than underlying public sector net debt, resulting in a £16 billion ($21 billion) increase in fiscal headroom. It expects the government to initially go for “a more cautious increase” in public investment, with additional outlays rising to around £10 billion a year.
In any case, the government will be careful about the amount of debt it issues, the bank said.
“One factor that may deter the government from a more significant increase in borrowing is that the Treasury is likely to warn the Chancellor of the impact of additional borrowing on interest rates,” it said.
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