BNY Mellon

Closing The UK’s Credibility Gap

It is abundantly clear that markets do not view the UK Chancellor’s budget plans as credible. While market participants will remain on guard for potential action from the Bank of England to stabilise the pound, its Monetary Policy Committee is realistically only in a situation to be reactive and play catch-up – unless the government makes changes to its current fiscal strategy. BoE Governor Bailey’s statement on Monday also suggests willingness to sit out the current stress and await more details from the Treasury before proceeding.

We think a good first step is introducing transparency. The Treasury on Monday announced that the independent Office for Budget Responsibility (OBR) will publish updated forecasts by the end of the year. This is insufficient, in our view, as one of the reasons behind the Gilt selloff was the lack of any costing plan. The process itself was already deemed insufficient, so arguably a modest fiscal stimulus without fiscal forecasts would have generated an adverse reaction, let alone something on the scale announced. That the chancellor said more tax cuts would come in subsequent budgets came as an even bigger shock.

With confidence in financing the government already at extreme lows, it is imperative that the revenue angle be established (now set for Nov. 23). Even if the forecasts are adverse, they would at least give markets enough information to adequately assess the requisite risk premia. Anything less would likely entail investors adopting the worst-case scenario and force the BoE into sub-optimal decisions, with risks to the wider economy.

The only information released so far has been from the Debt Management Office, which announced a massive revision to Gilt issuance forecasts for the remainder of the year. The entire September revision documented an increase of GBP62.4bn in issuance (+47%) compared to the April revision, which was already an upward revision from the original Spring Statement. The issuance will help support the government’s energy-price schemes and announced tax cuts. For example, the original Spring Statement included a hike to National Insurance fully hypothecated to support the National Health Service and other pressures on the healthcare system. The government has removed the hike but committed to funding, and this can only be attained through increased borrowing.

Previously, we noted that the Gilt market did not react adversely to the energy-support plan because of passive investment and a very favourable maturity profile, which at almost 14 years is twice the G10 average. The long-term structure should hold, but the market will be concerned about the increase in short-term supply, which accounts for more than half of the planned increase (see distribution below). In addition, the BoE will be adding supply to the market through Gilt sales, and this has led to the reaction in the front end.