With UK bond prices at multi year lows is it time to get into gilts?

When Labour was elected as the new UK government back in July last year, there was a lot of media commentary to the effect that after several years of Conservative party infighting, along with some financial markets’ volatility, that a new administration meant that the adults were back in the room. How long ago that seems now. 

With the Liz Truss budget still fresh in the market’s memory, the international credibility of the UK government and its fiscal management skills had only been partially restored in the twilight months of the previous administration as gilt yields fell from their 2023 peaks, and which helped to see a reasonably resilient UK economy grow by 0.5% in the first half of 2024.  

Having navigated such a turbulent period as gilt yields fell from their 2022 and 2023 peaks you would have thought any new administration would have been mindful not to spook overseas investors in the same way that a new incoming company CEO would not wish to scare its shareholders.  

As previous Bank of England governor Mark Carney once remarked, the UK has to rely on the “kindness of strangers” to keep the economy ticking over, given the size of our debt and deficit.  

Rather than doing that and seeking to reassure international markets that they knew what they were doing, the first thing the new government did was to accuse the previous administration of covering up a £22bn black hole in the UK economy, and say that an emergency budget was needed to stabilise the public finances.  

The approach was almost Ratneresque in its approach, and served to undermine both business and consumer confidence to such an extent that the economy slowed sharply in Q3, as it became apparent that the new administration was preparing the ground for a raft of new tax rises.  

The government then undermined its own argument about this so-called “black hole” by granting inflation busting pay awards to a host of public sector workers as well as announcing a raft of rather questionable green initiatives, including £22bn towards carbon capture. 

As a result of this approach any confidence that markets had that we were turning a page quickly evaporated as UK gilts yields started to edge higher again, even as the Bank of England started to cut interest rates, with the UK 5-year gilt rising from a low of 3.48% back in August to be back at 4.6% today. 

We’ve also seen the UK 30-year gilt rise from 4.35% to its highest level since 1998 over the same period to be trading just shy of 5.5%, with the 10-year gilt also rising to its highest level since 2008.  

While a number of people have said this has been a global phenomenon, and nothing to be overly concerned about citing the US as example, there is a wider concern at play here.  

It is true that bond yields have been rising largely due to concerns over sticky inflation and the possible impact of a trade war which could constrain central bank’s ability to cut rates as much as they would like over the next few years, the move in yields here in the UK has been outsized relative to its peers.  

This is because, having claimed that they would be sensible stewards of the UK economy in the lead-up to the election, the new Labour administration has been anything but, clobbering businesses with new and higher taxes and costs, as well as talking the economy into the ground with their attacks on the Conservatives legacy.  

Rather than setting their own agenda the new government decided to continue its policy in opposition of trashing the previous government, rather than on building a vision that overseas investors could get behind. 

It is true that over the same period, US yields have moved higher, but by nowhere near the same amount, while the likes of France and Italy, which have similar fiscal problems, pay much lower rates of interest on their long-term borrowings.   

Now with UK gilt yields at multi year highs and prices close to multiyear lows, and the pound sliding on foreign exchange markets, (never a good combination) the question being asked is whether gilts are good value at these prices, or is the so-called “moron premium” back with a vengeance?  

That’s a valid question, and relies on a number of factors, one of which is whether overseas investors have confidence in the government’s ability to manage the UK economy. 

On the current evidence that confidence is low, with growing concern that the UK economy is entering a period of stagflation, that of high or sticky inflation and low growth, amidst worries that the Chancellor may come back and raise taxes again, having seen her fiscal headroom wiped out by the rise in yields after she changed the fiscal rules to help fund extra borrowing to the tune of over £140bn over the next parliament.  

With the economic outlook continuing to look murky there have been some silver linings this week with some solid trading updates from a number of major retailers which show that the UK consumer still has some life in it, but they have all been notable by virtue that all of them were cautious about the economic outlook going forward.  

In short, the government is in a bind of its own making, and it needs to wake up to the fact that if they want international investors to fund their borrowing plans, they have to give the impression they know what they are doing.  

They also need to have a plan for growth, and not throw billions of pounds at their mates in the public sector without any prospect of returns or improvements in productivity, while continuing to clobber the wealth creators in the private sector.  

Higher taxes don’t create growth, and if you continue to raise taxes on wealth creators they will go elsewhere, and with governments all over the world issuing record amounts of debt the government needs to offer a compelling vision, as well as a return, to encourage investors to keep putting money into the UK.  

In short, while gilt prices are at their lowest in many years, that doesn’t mean they can’t go lower, and if the Chancellor comes back to the market later this year with plans to borrow more the fear is that yields could go higher still.  

After all it's not as if there aren’t other countries in the world who aren’t issuing debt at record levels to fund their investment plans in renewables and other such infrastructure projects.  

The UK is competing in a global market for bond issuance and needs to continue to require the “kindness of strangers” to fund its debt and its deficit.  

The government would do well to remember that, it's one thing to be critical in opposition. The requirements of government are different, and on current evidence there is little sign that anyone on the front benches recognises that fact, with the weakness of the pound, and rise in yields pointing to a market that has little confidence in the UK’s fiscal plans.  

It’s time for the new government to put on its big boy pants, wise up to the realities of global financial markets, and help put the “moron premium” on to the back burner of history.