By James Carter, Portfolio & Credit Analyst, Fixed Income, Waverton
DESPITE THE FOCUS ON BREXIT, A FUTURE LABOUR GOVERNMENT MAY REPRESENT THE LARGEST UNCERTAINTY FOR GILT MARKETS BUT WHY?
Approaching three months after the March 29th deadline, the failure to deliver Brexit has left the Conservative Party fractured and leaderless. As the contest for Theresa May’s successor rages on, Jeremy Corbyn’s Labour Party waits in the wings, hoping that the infighting will lead to a snap general election.
Corbyn’s 2017 general election manifesto, titled ‘For the Many Not the Few’, set out a radical tax and fiscal spending plan to reverse ten years of austerity since the Financial Crisis. Highlights from the socialist strategy include increasing corporate tax from 19% to 26%, scrapping student tuition fees, and the renationalisation of public utility companies (water, electricity supply, mail and rail).
While the manifesto aims to increase the public purse by up to £48.6 billion through additional taxes, the spending plans could top an estimated £70 billion per year – generating a £30 billion deficit. On top of this, nationalisation plans could cost the government £250 billion and ‘dealing with’ existing student debts could amount to upwards of £130 billion.
Question 1: Should we be alarmed about an increase in borrowing?
Corbyn certainly doesn’t think so, telling a 2017 conference in Wales “We should not be afraid of debt or borrowing”. But the UK’s debt pile is already at 87% of GDP (having grown from 42% since 2007) and adding over £250 billion of debt would bring that number to around 100%, not dissimilar to US and among the highest globally:
Source: Bloomberg, Labour, OBR, TaxPayers’ Alliance, Waverton. As at 18/06/2019
While the exact implications of ballooning debt remains under debate, interest payments are a good place to start: Already, over 5% of the UK fiscal budget goes to net debt interest payments, more than Transport (4.3%), Public Order & Safety (4.1%), and Housing & Environment (3.8%). Should Corbynomics lead to debt over 100% of GDP, with current interest rates unchanged, we would be spending more on the interest payments than on Defence. However, Corbyn will hope that the spending leads to a material increase in economic output. If that is indeed the case, the relative level of debt may not be as inflated as suggested and the cost of interest payments would be dependent on any subsequent changes in rates.
Question 2: How does a Corbyn government impact the Gilt market?
There are two opposing forces that could influence Gilts: firstly, it is likely that policy changes would have an adverse effect on market confidence and, together with the increase in corporation tax, would cause a contraction in investment. It is possible that this could steer the UK into a slowdown or recession, which traditionally causes Gilts to rally (yields to fall).
On the other hand, as the markets acclimatise to the new status quo, elevated fiscal spending could increase the supply of Gilts and lead to rising yields. This could be exacerbated if the credit rating agencies decided to downgrade the UK (currently rated AA / Aa2 / AA).
Question 3: How likely is all of this?
With only 19% of votes according to the latest YouGov poll, it is difficult to see an outright victory for Labour without the need for a coalition which could soften the rhetoric. However, political uncertainty is exceptionally high as Brexit drags on and a number of catalysts could drastically shuffle opinion polls. While this volatility persists, markets will be on edge.
In conclusion, Corbynomics has a number of potential outcomes for the United Kingdom and Gilt markets. The proposed fiscal spending plan may have many economic and social benefits, transferring wealth to lower income households with a higher propensity to consume thus increasing the economic multiplier effect. However, businesses will suffer from higher taxes and costs (i.e. from a £10 minimum wage), which could stifle investment and confidence. It is likely that the fear of Corbynomics could also take a toll on domestic stocks and Sterling, as apprehensive investors move money overseas fearing the imposition of capital controls.
The ultimate impact is difficult to judge, but it seems inevitable that the introduction of Corbynomics would adjust Gilt prices downwards to reflect the significant increase in supply and the elevated level of uncertainty.
By James Carter
Portfolio & Credit Analyst, Fixed Income
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