UK New Government's First Budget to Be Announced Tonight; Bond Market Closely Watches Fiscal Discipline

The government led by UK Prime Minister Andy Burnham will unveil its first budget at 12:30 local time on Wednesday (20:30 Beijing time), a critical test of global investors' confidence in UK assets. This is the new government's first comprehensive articulation of fiscal policy since Burnham became prime minister in July this year. The market widely bets that this budget will focus on fiscal discipline and avoid major surprises, an expectation that has boosted UK gilts, equities and the pound in recent weeks. Some investors believe that, compared with the turmoil in the eurozone bond market, UK gilts now actually possess safe-haven attributes. To keep this rally going, UK Chancellor of the Exchequer John Healey needs to avoid major long-term fiscal commitments such as large-scale tax cuts or expanded spending. Bond investors will pay particular attention to the deficit forecasts published simultaneously by the Office for Budget Responsibility and the gilt issuance plan of the Debt Management Office. Sebastian Mackay, investment director at True Potential, said: "What bond investors really want is a credible medium-term plan to ensure debt levels can peak and avoid an unsustainable path. All bond investors want to see that the supply of public debt will not explode." UK gilts edged lower on Wednesday, in line with the moves in other sovereign bond markets. Although UK borrowing costs have climbed amid the global bond selloff triggered by the Iran war, their volatility has been smaller than in many other developed countries. A Bloomberg index shows that UK gilts returned 1.9% in dollar terms this month, compared with a 2.4% decline for French bonds and an average 0.4% decline for developed European market bonds. UK equities have also outperformed comparable markets, with the FTSE 100 and FTSE 250 both beating the Euro Stoxx 50 this year. The pound has strengthened against most G10 currencies. A budget that does not sharply roil markets would contrast starkly with previous years, when investors sold UK assets over policy missteps. Some argue that UK bonds still carry a considerable "credibility premium" to compensate for the impact of those past episodes. ING strategists expect 10-year gilt yields to fall after the budget as investors price out the risk of spending surprises. Limited support, restrained scale So far, the measures proposed by the UK government have tended toward temporary, targeted support rather than large-scale spending subsidies. These include expanding the 150 ($199) "warm home discount," freezing fuel duty and scrapping some import tariffs. In addition, proposals to raise the bank levy have surfaced, which the market views as relatively positive for gilts. Filippo Alloatti, head of financials at Federated Hermes, said: "They won't take bold moves, but at the same time I think they are aware of the funding shortfall." He said that if the budget does not disappoint, the UK's image problem in global bond markets could improve. Investors will also closely watch the UK government's so-called fiscal headroom. Healey inherited nearly 24 billion of budget headroom from his predecessor Rachel Reeves, but that space has been eroded by accelerating inflation and rising borrowing costs caused by the Iran war. Primary gilt dealers currently estimate the headroom at about 15.2 billion. Lauren van Biljon, a senior portfolio manager at Allspring, said she expects "no unpleasant surprises on the fiscal space," but cautioned that key parameters could still change. On borrowing, the market expects UK gilt issuance this fiscal year to be about 3 billion more than the latest plan in April. The Debt Management Office is expected to increase the share of short-dated gilts and make greater use of Treasury bills. Investors will closely watch whether the UK government uses so-called public financial institutions (PuFIns), which allow the government to borrow in the gilt market to invest without damaging fiscal metrics. Budget seeks stability, growth gives way A broader concern is that a cautious, fiscally tight budget will do little to boost economic growth, potentially weakening business momentum and putting the pound at risk. However, the absence of leaks before the budget has helped restore some credibility. In previous years, policies were often publicly floated and then abandoned, causing sharp market swings. Peter Goves, head of developed market sovereign debt research at MFS Investment Management, said: "Actions speak louder than words. Gilt investors still want to see the actual deficit numbers."