Last weeks blowout is reminder to the government that gilt market will not accept “excess borrowing.”
The government has made a number of U-turns and the fiscal headroom has been “eroded” as a result of the winter fuel cut and welfare reforms reversals.
The government is being warned that fiscal tightening along with spending cuts will result in negative growth for the UK.
This could then lead to the Bank of England (BoE) being more aggressive with interest rate cuts should there be a more pronounced slowdown or a recession.
Oliver Faizallah, Head of Fixed Income Research at Charles Stanley said this blowout is “a reminder that the gilt market will not take kindly to excess borrowing, and this solidifies the current fiscal rules.
“The welfare/winter fuel cut U-turn is done and fiscal headroom has been eroded. This is not going to be unwound. Going forward, we look to the Autumn budget where we can likely expect taxes and spending cuts.
“Ultimately fiscal tightening and spending cuts will be negative for UK growth.
“This may lead to a more pronounced slowdown/recession leading the BoE to be more aggressive with rate cuts which will be positive for gilts over the next 12-months.
“In the meantime, we expect an uncertainty premium to remain in the UK gilt market and long end yields to trade at elevated levels. All things that would be bad for bonds (an increase in issuance or fiscal loosening) would not make sense.”
