Liontrust’s Phil Milburn explains in this video why bond markets have a fragile confidence in the UK and what they need to see from the government, BoE and the economy to increase belief. He also discusses the drivers of recent moves in the UK gilt market
Simon [00:00:11] I'm Simon Hildrey and I'm with Phil Milburn to talk about the UK economy and bond market. Phil, there's been much chatter about taxes, are you expecting taxes to go up in the autumn?
Phil [00:00:23] It is inevitable that taxes are going to go up at the autumn budget. At the moment, the UK just does not have the fiscal headroom and there was so little, just under £10 billion, £9.9 billion in the previous budget and that's been eaten away by a combination of tax raise undershoot, little growth undershoot and higher yields in the gilt market. So are taxes going up? Definitely yes.
Simon [00:00:49] Is there any other way to raise the money?
Phil [00:00:52] The interesting bit is which taxes are going up. Obviously, Labour have pledged not to touch employee, National Insurance contributions, as well as income tax and VAT. They're going to have to break some pledge. They're going to either have to break one of those or look at other taxes. One of the things that has been mooted around a lot at the moment is a wealth tax. And this is a real learning exercise for Labour. When they came into power, they started cracking down on non-doms. Unfortunately, that has been very self-defeatist. There's actually been less tax take because of it, because enough people have left. And that's the problem with taxing financial capital. It's incredibly mobile. Physical capital is easier to tax. The other option is of course, to cut spending. And not all of their spending pledges can be honoured. So it's time to make some really difficult decisions for the Labour government.
Simon [00:01:50] And how are bond markets reacting to this?
Phil [00:01:53] The bond markets have retained, I would say, a fragile confidence in the Labour government, and I would it is very fragile. We haven't had the full scare of the Truss-Kwarteng budget, but at the moment there's just that fear of how much further will they keep pushing it. There needs to be a real exercise in regaining credibility. And let me be clear here, getting rid of Reeves won't help at all. That will probably be seen as a sop to the Labour left, rather than necessarily anything constructive. There needs to be a better long-term plan. Not all of the budget reconciliation or books balancing can be done at the end of the forecast period, four to five years out. They need to actually have a better plan of how to generate growth, getting on and doing it, how to boost the UK economy, and how to raise taxes and cut spending without destroying that growth, rather than just fiddling at the edges and leaving the UK economy basically just stuck in a bit of a quagmire.
Simon [00:02:54] And do the gilt yields reflect that? Is that what's driving the gilt yields?
Phil [00:02:59] Partly yes, and we've seen what the market refers to as a steeper yield curve, longer dated bonds needing more yield to actually be prepared to lend to the UK government for a longer-term because of this risk. And that's the fragility, and governments simply cannot afford to lose the confidence any more of the bond market. I actually think UK gilts are very cheap, both in nominal and real yield. And in our relevant strategies, we are overweight there. We have a longer duration exposure, but I'm not prepared to take that to our limit longer simply because I don't have the confidence that Labour, when push comes to shove, are both willing and able to do the right thing for the economy.
Simon [00:03:45] There's been talk of another rate cut in August, but how many more would you expect this year?
Phil [00:03:50] With the mixture of the inflation data and labour market data that the Bank of England has, at the moment they're taking what they call a gradual and careful approach, which is really interpreted to mean one rate cut a quarter. As you say, August looks like a done deal. But unless the labour market in the UK significantly deteriorates between now and then, they will continue with their gradual and careful approach and signal one more rate cut likely in the fourth quarter of the year. So two more for the year is the likely scenario.
Simon [00:04:25] So would you say you're now less or more confident about economic growth in the UK than you were say, six months or a year ago?
Phil [00:04:34] Slightly less confident. The incoming Labour government were dealt a really tough hand of cards. But they've not handled it well at all. They've blown a lot of the goodwill they had with the electorate, within their own party, and with the financial markets. And what would make me more confident is if Reeves and Starmer start to take the really tough decisions at the budget. They need to break one of their electoral pledges and focus on getting growth going. And there are levers you can pull. I don't want to be too pessimistic. The UK should be an economy that can grow better. Invest more in education. Look at all the great education and science parks we have in the Oxford-Cambridge corridor. Look at our leading financial system. Look at the fact we have an enormous trading block just right next door to us that we've recently raised red tape with. That could all be cut again. There's so many things that could be done. Or GB Energy, that could be invested and boosted. The UK stock market is still cheap. Let's get UK investors investing in it. So much could be done if there was just a bit more will and way of doing it.
Simon [00:05:43] Thank you, Phil. Thank you for watching. We'll see you next time.
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