Gilts under pressure as investors brace for higher spending under new PM

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Ian Smith, Sam Fleming and Ashley Armstrong in London

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Andy Burnham’s first day as prime minister met a frosty reception in the bond market, with investors bracing for higher spending and saying the Labour leader “needs to build some fiscal credibility”.

Gilts underperformed other markets on Monday after Burnham started to lay out his economic agenda, including targeting the “flexibility” within the fiscal rules that govern UK borrowing.

“I’ve said we’ll stick to the fiscal rules, and by that I mean the existing fiscal rules, and use obviously any flexibility within them,” Burnham told reporters.

Ten-year gilt yields rose 0.08 percentage points to 5.04 per cent as the price of the debt fell, underperforming other big bond markets. Equivalent yields on French and Italian debt rose just 0.02 percentage points on the day.

“So far we have only had hints that lead us to think that there will be more spending and less reform,” said Stephen Jones, chief investment officer at Aegon Asset Management. “[It’s] early days, but markets do want some detail.”

Investors said a move higher in yields after a flurry of remarks from Burnham on his policy plans, including a planned cost-of-living package, showed a gilt market that is on edge over political risks, adding to inflation risks from higher energy prices.

This is despite Burnham repeating his pledge to “stick to the existing fiscal rules”, which include reducing public debt as a share of GDP.

After gilts markets had closed, John Healey, the former defence secretary and an ex-Treasury minister, was appointed chancellor. Investors said he was a centrist figure but thought he would be likely to push for higher spending for the armed forces. Sterling was little changed at $1.344 on Monday evening.

John Stopford, head of managed income at Ninety One, said the sensitivity in the market “shows how little room for error there is”, adding: “[It is] not very surprising that [Burnham] wants to use any flexibility within the rules, but he also needs to build some fiscal credibility.”

A surge in oil prices since the Iran war drove UK borrowing costs to their highest since 2008, reaching as high as 5.2 per cent in May, with some investors also concerned over a shift left in Labour economic policy that would entail more borrowing. The UK’s borrowing costs are already the highest in the G7, and the country spends more than £100bn a year on debt interest costs.

Investors reacted uneasily to Burnham’s pledge to look at an increase in the personal allowance, which would amount to a large tax cut. Unfreezing the personal allowance next year alone would cost £3.7bn by 2029-30, according to calculations by the Resolution Foundation think-tank.

Any such change needed to be properly funded, it said, adding “there is no spare cash lying around”.

Paul Dales, UK economist at Capital Economics, said bond markets were under pressure in general given the hostilities in the Middle East and movements in energy prices, but that the tone of Burnham’s comments was adding to the decline in gilts.

“There is a danger that Andy Burnham is falling into the same trap as Rachel Reeves and Keir Starmer” when they took office, he argued, pointing to the first Budget at which Labour loosened fiscal policy.

Given the prospect of rising inflation, easing fiscal policy further in the near term could push prices up even higher, Dales said. “We are in a situation where inflation is probably going up because of the war in Iran and loosening fiscal policy in that environment would only exacerbate that.”

“Given gilt yields feed directly into government borrowing costs and fiscal headroom, one of the most effective ways for any prime minister to create room for manoeuvre is to maintain market confidence,” said James Carter, co-head of fixed income at W1M. “That means being disciplined not just on policy, but on communication.”

The business community gave a cautious welcome to the new prime minister, urging him to work with the private sector.

“Business leaders share the ambition of building a more resilient and prosperous economy, but success will depend on creating the conditions that enable firms to invest, innovate and grow with confidence,” said Jonathan Geldart, director-general of the Institute of Directors.

“Maintaining a competitive and predictable tax environment will be essential if the UK is to attract the investment needed to deliver sustainable growth.”