Britain's New Government and Fiscal Outlook

By William Schomberg and David Milliken
LONDON (Reuters) –
Britain's new government is unlikely to upset investors in its first budget this month, with a more positive debt outlook than financial markets anticipate, according to executives from global asset manager PIMCO.

Finance minister Rachel Reeves is set to unveil her debut tax-and-spending plans on October 30, following former prime minister Liz Truss's crisis-inducing tax cuts over two years ago.

Speculation about increased government borrowing under Prime Minister Keir Starmer's Labour Party, which returned to power in July after 14 years, has contributed to recent gilts underperformance.

Peder Beck-Friis, a senior vice president at PIMCO, expressed expectations for a tight fiscal outlook in the UK, forecasting a decline in the deficit in the coming years. He remarked, "We will be surprised if the government announced anything that would lead markets to question fiscal credibility."

He also suggested that financial markets would soon anticipate more Bank of England interest rate cuts as inflation and growth outlook shifts lower. "We continue to like UK government bonds," he added, noting that the terminal rate in markets appears too high based on easing inflation expectations.

GILTS IN FAVOUR

Following weaker-than-expected inflation data, British government bond prices rose sharply, though the gains only partially addressed prior underperformance. Beck-Friis indicated that gilts' yields are attractive, both in absolute terms and for potential capital appreciation.

PIMCO's chief investment officer for global fixed income, Andrew Balls, highlighted the anticipated fiscal restraint under the new UK government compared to larger deficits in the US, reiterating their preference for gilts as a reliable source of duration.

On the UK's economic outlook, Beck-Friis noted stagnant growth prospects around 1% to 1.25% annually due to weak productivity, tighter immigration, and increased workplace dropouts since the pandemic. However, there is optimism regarding the government's plans to reduce red tape and accelerate infrastructure and housing construction, as achieving higher productivity growth presents a challenge for the government.