Bond vigilantes give Hammond free budget rein

Markets largely shrugged off Trump’s tax cuts and spending increases

Chancellor of the Exchequer Philip Hammond, a minister with many political enemies, may find the bond market a less fearsome foe.

While bond vigilantes have bared their teeth in recent weeks by punishing Italy’s populist government for its spending plans, the UK is unlikely to face the same fate if Hammond opts to loosen the purse strings at today’s budget.

The US may provide a better guide. The bond markets largely shrugged off Donald Trump’s tax cuts and spending increases even as they pushed the deficit to a six-year high.

“Unless the change by Hammond was so big that it completely altered the dynamics of the UK economy, where we are now you could have a little bit more debt and it doesn’t matter,” said Kacper Brzezniak, a portfolio manager at Allianz Global Investors, which oversees €524 billion ($605 billion; Dh2.19 trillion) in assets. “For some of the wealthier countries like the UK and US, there’s actually very little correlation between the deficit you run and yields.”

The leeway might be useful for the Chancellor as he tries to deliver Prime Minister Theresa May’s pledge to end almost a decade of austerity. Whether Hammond, who has been the focal point of attacks by Brexiteers in recent months, decides to make use of it is another matter. A fiscal conservative, he’ll try to stick to his self-imposed rules, and his pledge to balance the books by mid-2020 — while also keeping some money aside to deal with any fallout from Brexit.

Controversy unlikely

“With the narrowest of majorities, the likelihood is that the government will find it hard to push through anything even slightly controversial,” Elizabeth Martins, senior economist at HSBC, wrote in a note last week. Still, the better public finance data means that “the Chancellor may not have too many hard choices to make.”

The UK budget comes as European Union leaders drag Italy’s populist government over the coals for its defiance of spending rules. The market’s reaction to the turmoil has evoked memories of the Eurozone debt crisis.

The spread between Italian and German 10-year debt broke through 300 basis points this month, the widest in five years, while a spread of 400 is seen as a level that would put unsustainable pressure on the banking system.

Primary dealers predict that borrowing will actually fall next year. To fund extra spending, Hammond may therefore rely on tax rises and a windfall from better-than-expected public finances.