In recent weeks, encouraging data on UK wages and inflation has emerged. Wage growth has slowed and, most recently, the Office for National Statistics reported that September inflation came in below the Bank of England’s (BOE’s) 2% target. UK government bonds are beginning to reverse their recent underperformance compared to US Treasuries and German bunds, but one major obstacle may stand in the way of gilts’ rebound. In our view, the upcoming Autumn Budget on October 30 remains the key to unlocking sustained gilt outperformance.
Moderating inflation and wage growth typically would support the case for additional BOE rate cuts. However, investor concerns are rising over the possibility that the upcoming Budget could be more fiscally expansionary than expected, leading to increased gilt issuance and potentially slowing BOE rate cuts. Fueling the fears are reports that suggest Chancellor Rachel Reeves is seeking a buffer to ensure day-to-day spending is covered, with any borrowing directed toward investment projects. However, we believe the Chancellor is likely to prioritize market stability while actively seeking to avoid a “Truss-style” budget and the subsequent fallout. The Chancellor has talked about wanting to be fiscally tight and now needs to back up those words. Any increase in non-investment spending will likely be offset by higher taxes to avoid unsettling the markets.
Since investment projects tend to be slower to implement and focus on boosting both supply and demand, increased capital spending would not be expected to significantly alter the Monetary Policy Committee's inflation outlook. As such, the Budget's impact on the BOE's policy direction may be limited. With gilts currently trading at wide spreads compared to bunds and Treasuries, we see a potential opportunity for this gap to narrow following the Budget announcement.
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