The Bank of England’s rate cutting trajectory could now be less aggressive as a result of Labour’s first Budget, fund managers suggest. Higher-than-forecast borrowing triggered a rise in government bond yields last week amid fears that the fiscal plans will be inflationary.
Central to last Wednesday’s speech was an increase in employers’ national insurance contributions, which is estimated to raise £25 billion by the end of the current parliament. Overall tax increases as a result of the Budget are expected to be around £40 billion.
There were also measures targeted at savers and investors. There was a hike on capital gains tax (CGT) for both basic-rate and higher-rate taxpayers, and some tinkering with inheritance tax (IHT) to ensure defined contribution pension pots will now be brought into the IHT regime from 2027. The British ISA is also no more.
What Was The British ISA? Read Our Original Coverage Here
Over in the equity markets, gambling stocks escaped a sin tax drubbing, but oil and gas companies got an increase in the windfall tax on their profits. The soft drinks industry was handed fresh levies of its own, while airline companies now face higher duties on economy class short-haul flights—and for the very wealthiest using private jets.
Interest Rate Cut Still Expected
But it was the bond markets that displayed the most notable reaction, with UK gilt yields spiking once more on the news that the government will borrow more to fund investment in public services and healthcare infrastructure. The pound also fell against the dollar.
Gilts across the yield curve have gained since the Budget on Oct. 30, with the 2-year bond yield rising from 4.13% to 4.41% and the 10-year gilt yield increasing from 4.22% to 4.43%.
Fixed income managers now suggest the Bank of England could be less aggressive in cutting rates in forthcoming meetings. The next meeting is on Nov. 7, when the Bank is still expected to cut interest rates from 5% to 4.75%. The next meeting is on Dec.19 and the first 2025 meeting is on Feb. 6.
Nicoló Bragazza, associate portfolio manager at Morningstar Investment Management, says there is now more downside risk for UK debt.
“A lot of forecasts are based on a certain path for growth and productivity, which then impacts tax receipts, so that is also very uncertain. Going forward, there is more downside risk than what has been priced in by the market for UK debt.”
One Budget Can’t Fix Everything
Michael Field, Morningstar European Equity Market Strategist, says the government could never fix everything in one speech.
“There are a lot of views about the Budget in the media, but ultimately [Labour] kind of pre-warned everyone by saying that it was going to be a tough Budget in advance. The big thing is the national insurance contribution. They have made £40 billion [in taxes] and £25 billion comes from that.
“The government seems to be fulfiling its mandate for why it was even elected in the first place. You are never going to fix the entire country and everything with one Budget. But it seems like a step in the right direction.”
Below, we have assembled a collection of reactions from bond and equity fund managers.
Fixed Income Managers React to Labour’s First Budget
James Lynch, Fixed Income Investment Manager at Aegon Asset Management
“The initial market reaction has more to do with the Bank of England’s rate path than the supply of gilts. The markets think the Budget will lead to higher growth in the short term and a higher inflationary impulse leading to fewer BoE cuts.
“Personally, I would rather see the BoE’s own interpretation of the Budget at its Nov. 7 meeting before reaching that conclusion. In the meantime, we will have US labor market data and US election, which is still likely to be the main driver of yields for now.”
Clive Beagles, Fund Manager, JOHCM UK Equity Income Fund
“Ironically, the biggest surprise was actually not something of Rachel Reeves’ doing. Rather, it was the OBR’s inflation forecasts for 2025 [2.6%] and 2026 [2.3%], and that came right at the start of the Budget, so, initially, people didn’t react.
“The OBR hasn’t got the best record on economic forecasting. The last inflation for the UK dipped below 2% at 1.7% and our expectation is that it will oscillate at around 2% for the next few months. That inflation forecast is why the gilt market ultimately reacted in the way that it did. Initially it was quite calm. Then, as you saw yesterday afternoon and to some degree this morning, gilt yields have risen by 20 to 25 basis points.”
“If that inflation forecast is even half right, then the trajectory of rate reductions by the Bank of England is going to be more shallow, slower, and we will get fewer of them than anticipated. And I think that’s sort of what the gilt market is pricing out.
“Clearly there is a cohort of people that want to make a big thing about bond yields going up, and they’re asking if it’s just a rerun of 2022. But the reality is bond yields are going up everywhere around the world now that the chances of Trump winning have increased quite significantly. He might even win majorities in all the houses, and that’s probably quite inflationary.”
Shamil Gohil, Fixed Income Portfolio Manager at Fidelity International
“In terms of gilt issuance remit, which is what matters for yields, approximately £20 billion more of issuance is pencilled in, and skewed to the long end, which was not expected and is leading to some curve steepening.
“Overall, I think gilts can continue to perform here and reverse some of their cross-market underperformance, especially as the focus shifts to the US election and associated fiscal expansion there.”
Vivek Paul, UK Chief Investment Strategist, BlackRock Investment Institute
“The relative stability in bond risk premia is something the government will hope permeates into the stock market, too, reinvigorating foreign investment flows.
“Over the last 20 years, markets have gone from perceiving UK equities to be broadly as risky as their US counterparts to materially more so now—when accounting for the different types of stocks in each index.
“We believe the market will reduce the risk premia on UK assets and see yields falling over time, so we’ll broadly position our short-term tactical views for this. The relative political stability afforded by the summer’s decisive election result, and our view that the Bank of England is likely to cut rates more than markets currently thinks, means we remain overweight UK equities and UK gilts.”
Taxes Up: Read Our Budget Coverage
• Autumn Budget: Capital Gains Tax Changes Dominate
• Inheritance Tax Blow for Pension Savers in Autumn Budget
• UK Stocks: Budget Winners and Losers
UK Equity Managers React to Labour’s First Budget
Alexandra Jackson, Fund Manager, Rathbone UK Opportunities Fund
“Sterling rallied in the immediate aftermath, suggesting the Chancellor has threaded the needle of raising the taxes she needs without spooking investors.
“Even the Alternative Investment Market [AIM] is staging a punchy relief rally. The IHT break has been halved, but this is less onerous than feared. Crucially, it gives certainty to AIM investors.
“We think that, after this cut, it’s unlikely this issue will be revisited again so that should allow the index to return to a more fundamentals-driven era. Our fund has 10% of its assets invested in the AIM. In general, small- and mid-caps are markedly outperforming large caps, as markets digest the Budget.”
Jonathan Brown and Robin West, Co-Managers of Invesco Perpetual UK Smaller Companies Investment Trust
“The future of the AIM market was at risk if an IHT change had been imposed in full on AIM shares. That would likely have led to an exodus of many of the largest AIM companies to the main market.
“The new 20% IHT rate on qualifying AIM companies held for two years should remain attractive for individuals looking to mitigate their IHT liabilities, particularly after personal pensions are now being brought into the scope of IHT too.”
Michael Browne, Chief Investment Officer at Martin Currie
“With the long-term spending review in next spring, tougher decisions may be on the horizon. This Budget is unlikely to deter the mix of overseas investors. Right now, the UK is affordable and offers stability.
“However, there is a word of warning from the Office for Budget Responsibility: ‘over the forecast, business investment falls as a share of gross domestic product as profit margins are squeezed, and the net impact of Budget policies lowers business investment.’”
Anna Farmborough, Portfolio Manager, Ninety One UK Equity Income Fund
“The types of stocks we invest in are high quality businesses that are quite protected from things like the Budget, so we are reasonably sanguine about the impact.
“From a stock-by-stock perspective there are a couple of companies that may be more impacted than others. The biggest impact is probably from the national insurance contribution going up. That will have a cost impact [for businesses] with more part-time employees.
“Wetherspoon JDW, [is a holding] we own [so the national insurance hike will be] quite a big cost headwind for them. It is very challenging for the hospitality sector because it is already competing with supermarkets, which can sell alcohol at a discount.”
Ben Needham, Portfolio Manager, Ninety One UK Equity Income Fund
“[The Budget impact] is mixed but on a net basis I think it is neutral.
“The positives include wages going up, which can flow into wealth platforms via savings. There was no major change made to pensions but one slight issue is that DC pensions will now be exposed to IHT.
“However, the quid pro quo will be that customers or investors will probably need more advice with regards to managing their tax affairs more efficiently, and that is good for a company like, say, AJ Bell AJB where the majority of customer assets are exposed to advisors. Those advisors will no doubt be busier because of the Budget.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
