Boris and Bonds: The Impact of the UK General Election on UK Gilts
With the UK general election kicking off in proper this week, the three parties currently polling highest have been quick to roll out lavish spending promises which would represent a significant break from nearly a decade of Coalition and Conservative austerity. Such a drastic increase in UK government borrowing will lead to a significant increase in UK Treasury gilt issuance, putting downward pressure on bond prices and upward pressure on yields.
With public dissatisfaction at the state of living standards and public services after harsh spending cuts, freezes on public sector investment and wages now clear (and arguably playing a role in motivating the Leave vote), the Conservatives, Labour and Liberal Democrats appear keen to out-do eachother in their commitments to turn on the spending taps. The scale of these commitments would lead to levels of public expenditure not seen in the UK since the 1970s, with Labour framing this electoral cycle as a “once in a generation” chance to implement the current leadership’s socialist policies, creating a £150bn fund to ameliorate the “human emergency” they claim has been created by the Tories. This pledge has been made on top of already large spending commitments made in Labour’s 2017 manifesto. Sajid Javid has pledged that a Conservative government would loosen their fiscal rule, balancing the day to day budget but running a deficit of up to 3% of GDP to fund investment. Liberal Democrat leader Jo Swinson has made a £50bn “remain promise”, arguing that if the UK ends up remaining in the European Union this would allow a Lib-Dem majority government to inject £50bn into public services, as Brexit related uncertainty eases and growth forecasts are revised upwards.
Such exuberant spending promises could have a significant impact on UK gilt prices and yields. PIMCO forsees a significant increase in bond issuance, putting downwards pressure on prices. As a result the global investment management firm has sought to offload its holdings of UK government bonds, becoming “underweight” in its holdings of UK government bonds, which are traditionally seen as a safe-haven investment with gilts seen as virtually “risk free” if held to maturity. However, some analysts have commentated that this is reflective of a longer-term strategy and attitude of PIMCO in particular and that fiscal profligacy following the conclusion of the 2019 general election will not have such a depressive effect on bond prices. PIMCO has made such arguments on several occasions since 2017, and has not yet been proven correct. This may be the case again, for a number of reasons.
Firstly, the leading political parties in the UK have been keen to boast their spending plans, but less clear thus far on how they will be financed. Although much will come from increased borrowing through Treasury gilts, some will also come from tax raises, mitigating the effect of new bond issuance on bond prices. Furthermore, the Bank of England, through its quantitative easing program, has purchased £435bn of UK government bonds, helping to absorb new bond issuances following the 2008 Global Financial Crisis. Although the BofE isn’t currently running a quantitative easing program, with interest rates hovering near the zero lower bound and global growth slowing to near recession levels, a return to some form of quantitative easing or other unconventional monetary stimulus isn’t impossible. Indeed this was an argument echoed by Andrew Benito in his interview with The Review earlier this term, that central banks and governments will enjoy ah increasingly close relationship, with central bank asset purchases effectively acting to finance fiscal stimuli.
Overall, it seems likely that the enormous spending pledges of all the leading candidates to form the next UK government will have a large impact on bond issuances, with the Conservatives less likely to hike taxes to finance spending, and Labour spending pledges so large that even major tax hikes will prove insufficient to fully finance them. This increase in UK gilt issuances will increase the supply of government bonds, and could have a depressive effect on bond prices. But with quantitative easing programs having hoovered up new bond issues in the past, the general election spending pledges already being priced into the bond market, and the supply of other competing government bonds such as US Treasury bonds also increasing, falling UK bond prices may have a lesser impact on investors. All of this makes for an interesting general election campaign for investors, not only because of its implications for Brexit but because of the potential impacts of changes to fiscal policy over the next half decade on a range of asset classes.