James Lynch, investment manager at Aegon Asset Management, comments on what the upcoming UK election means for the gilt market.
James Lynch, Investment Manager, Aegon Asset Management:
The gilt market has a lot to deal with this year, and a general election was always going to be one of the main events to navigate. Calling the election for July was a surprise – an early election in May or later in November seemed the more obvious choices.
In normal circumstances the most dominant factors influencing the gilt market are the BoE policy rate and the data inputs into that decision, along with bond supply and the global financial market backdrop. However, given the experience of the bond market in October 2022, politics moved higher up on the lists of concerns. The political episode which ended with the downfall of the previous chancellor and the prime minister started with concerns that the Liz Truss-led government did not take seriously the fiscal situation they were faced with, given they called for more unfunded spending with outlandish forecasts while ignoring the OBR and, to an extent, the BoE. For a country that relies on a significant ongoing flow into government debt to fund such largesse that episode was unwise at the very least.
So, as we have a general election called for 4 July it is inevitable that we at least ask the question, what does this political event mean for gilts?
At this point, I don’t think we are going to see a repeat of the gilt market collapse of 2022. In fact, there are more positives for gilts than negatives if the polls are correct in pointing to a large Labour victory. First, an early election means there will be no final ‘give away’ budget from the government to win over last minute voters. Second, the new parliament with a large Labour majority will bring a sense of stability; most likely, five years of the same chancellor and prime minister should mean a coherent fiscal plan that is unlikely to be deviated from in short order. Indeed, given the experience of 2022, the Labour party is highlighting the importance of the OBR and the BoE. If Labour wins, we will see a spending review first, followed by an autumn budget in October/November 2024. The potential new government ‘gets it’ in terms of there being no quick fixes to a return to growth, and they know they cannot spend their way to growth via borrowing in the gilt market (in contrast to the Liz Truss government). At the margin, there will likely be an increase in tax take as extra investment will be needed in some public services, and the plan for GB energy.
A Labour government should also be helped by the improving macro backdrop. A falling inflationary environment and, if the market is correct, a fall in interest rates by the end of the year, will help the fiscal situation given the sensitivity of the debt pile to both.
There will be headwinds for the gilt market this year, including another record year of gilt supply coming, but if the polls are correct, a move towards political stability will be most welcomed by the market.
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