A Jeremy Corbyn government post the next general election has the potential to send gilt yields soaring. Markets fear the worst over spending and nationalisation plans that Corbyn has been pedaling, but that outcome is far from clear.
Some estimates put 10 year Gilt yields at 1.6% – almost double today’s yield of 88bps. Policy makers led by Mark Carney have suggested base rates should be higher than today’s 75bps. If base rates were up 25- 50bps higher, expectations are that would push Gilt yields higher. However, the recent rally in global bond markets has pushed out expectations of UK rate rises.
Higher base rates and Gilt yields still seem a way off but UK politics have been unprecedentedly volatile. But what is the case for the gilt market if we do indeed see a Corbyn government occupying Number 10 in the near future? Like the Tory leadership race, it is hard for traders to gauge this one.
According to Adrian Hull, head of fixed income, at Kames Capital:
“Market’s do not like uncertainties. As outlined in insufficient detail, the Labour Party’s spending and nationalisation policies could end up with a few extra hundred billion of debt on the Bank of England’s balance sheet. Whilst it might be pointed out that the Bank already has £425bn of Gilts, these were purchased from the market in return for cash for investment elsewhere. The Labour Party has spending plans that will be materially beyond that of the current budgetary balances, and further debt is likely to be issued (or created at the Bank) due to nationalisation programmes.”
However, Hull says that it is not so much the extra debt but rather the real concerns over the coercive expropriation of assets that is being suggested. The bankrupt Northern Rock model (as suggested by some politicians) is not a fair model to repay investors in water companies, for example. It is this negative investment backdrop which makes the 1.6% estimate for gilts look too low. Higher taxes will slow growth but importantly those who can move assets and wealth out of the UK will do so.
Will Jeremy Corbyn mean a crisis for UK gilts?
This, along with reduced international confidence could see a weaker pound and a reduction in appetite for UK assets – a reversal of the “kindness of strangers” as Mark Carney noted in 2016. Indeed, as a reminder it was only at the start of the year that Gilts were above 1.3% with a government albeit ham-fistedly aiming to deliver a Brexit deal and some economic certainty.
But Hull’s is not the only viewpoint. Despite concerns around the checks and balances of a future Labour government there is no sign that the Labour party will aim to change the independent status of the Bank of England that the Blair government established in 1997 – indeed it was not a manifesto point in the 2017 election. It might be something Corbyn would be tempted to do, but he lacks the support within his own party for such a bold step.
“The Labour Party’s plans will likely see an increase in debt but this should also spur growth in an economy that is still below potential,” says Sandra Holdsworth, a colleague of Hull’s at Kames and head of rates. “Whilst some are keen to talk about ‘un-costed’ plans when it comes to Labour, recent comments suggest planning around market responses. The elephant in the room remains the low, no inflation environment that we are in globally. That and Trump’s trade policies with China and Mexico have sent bond prices rocketing.”
With core inflation in the US sinking to 1.5% and deflationary pockets in Europe there remains more of a deflation than inflation risk. It’s difficult to see UK yields move to 1.6% with this backdrop.