PIMCO says UK budget unlikely to shock markets, gilts look attractive

By William Schomberg and David Milliken

LONDON (Reuters) – Britain’s new government is unlikely to upset investors in its first budget this month and the outlook for its debt is more positive than financial markets appear to believe, senior executives from global asset manager PIMCO said.

Finance minister Rachel Reeves is due to announce her debut tax-and-spending plans on Oct. 30, a little more than two years after then-prime minister Liz Truss plunged the UK government bond market into crisis with her plans for big tax cuts.

Speculation about increased borrowing by the government of Prime Minister Keir Starmer – whose centre-left Labour Party returned to power in July after 14 years in opposition – has contributed to an underperformance of gilts in recent weeks.

“We do expect the fiscal outlook in the UK to be tight, and we continue to expect the deficit to fall in future years,” Peder Beck-Friis, a senior vice president at PIMCO, said in a Reuters interview with executives from the firm on Wednesday.

“We will be surprised if the government announced anything that would lead markets to question the fiscal credibility that we’ve seen in the UK over the last two years.”

Beck-Friis said he believed financial markets would price in more interest rate cuts by the Bank of England once markets and the BoE realised the outlook for inflation and growth was lower than they thought, following similar shifts in the United States, Canada and New Zealand.

“We continue to like UK government bonds,” he said. “I think one of the key premises is that we think that the terminal rate that’s priced into financial markets looks high relative to our expectation and that inflation will continue to ease.”

GILTS IN FAVOUR

British government bond prices rose sharply on Wednesday after weaker-than-expected inflation data but those gains narrowed only some of their recent underperformance.

“Gilts yields are attractive on an absolute basis in terms of yield, but also we would expect some potential capital appreciation on these holdings over time,” Beck-Friis said.

Andrew Balls, PIMCO’s chief investment officer for global fixed income, said the expected fiscal restraint in Britain by the new government stood in contrast to much bigger deficits in the United States.

“We tend to favour gilts as one of the better global sources for duration,” Balls said, speaking in the same interview.

On Britain’s economy, Beck-Friis said weak productivity improvements, tighter immigration controls and higher levels of workplace dropouts since the pandemic meant growth was likely to be stuck at around 1% to 1.25% a year, similar to the euro zone.

Balls said one area for optimism was the government’s plan to reduce red tape and speed up construction of infrastructure and housing.

“It’s not easy for a government to raise productivity growth, but to the extent they’re able to deliver on it in the planning permission stuff, (it) seems like a positive if they’re able to do something significant there,” he said.