Further rises in interest rates
This is a substantial fiscal stimulus and will clearly put additional pressure on the Bank of England to tighten monetary policy. In our previous forecast for the Bank Rate, we envisaged a 3.5% peak in February 2023. This was based on additional fiscal stimulus of around £45 billion in fiscal year 2022-23. The £72 billion fiscal boost in the current year, with further easing to come, has prompted us to revise our forecast for the terminal Bank Rate forecast up to 4.0% (based on 75bp hikes in November and December and a final 25bp rise in February).
Gilt yields will rise further, with 10-year notes reaching 4.5%
One key takeaway from the UK Government’s ‘Growth Plan’ is clear: there will be a substantial, multi-year – and in fact unprecedented – increase in Gilt supply for private investors to absorb.
The government has announced a pandemic-scale fiscal stimulus, with gross Gilt issuance this year set to top £190 billion and, in all likelihood, approach £250 billion in 2023. But unlike during the pandemic, there will be no offsetting monetary policy stimulus (in the form of quantitative easing) to absorb all of the additional issuance. In fact, the Bank of England confirmed on Thursday 22 September that it is set to begin active sales of its Gilt holdings imminently.
There is also a global demand-side shift as investors opt for cash in a high-inflation, low-growth world. For Gilts in particular, it is hard to see major sources of investment demand keeping pace with the vast increase in supply.
Taken together, these effects are likely to exert significant bearish pressures on the Gilt markets in the weeks to come, particularly at the long end of the curve. As a result, we are revising our ten-year Gilt yield target up from 4.0% to 4.5% as the market prices in the deluge of supply and lack of demand. Rising yields will of course pass through to corporate bond markets, meaning higher borrowing costs for issuers of sterling-denominated securities.
The pound will come under further pressure
Sterling’s slump in the immediate wake of the mini budget was unsurprising. The provisions contained within it were only seen to be exacerbating the UK’s already poor twin deficit position, particularly with respect to the current account.
That said, we expect further weakness for the pound, both against the euro and the US dollar. In fact, it’s hard to imagine a feasible policy mix that would persuade the FX markets to drive a rebound in the pound.