LONDON, July 21 (Reuters) - Britain's new Prime Minister Andy Burnham appears to have room to juggle some popular economic policies without dropping the ball on the bond markets. Investors are likely cheering him on so that they don't have to dodge much bigger risks down the line.
After weeks of speculation and intrigue, Burnham was finally confirmed as premier on Monday, replacing Keir Starmer as the country's seventh PM in a decade. Compared with Starmer's careful — some might say overly careful — stewardship of the economy, Burnham is seen as something of a maverick, someone potentially willing to take more risks to underline his "man of the people" image and burnish his credentials among the left wing of the ruling Labour Party.
Budget room, political risk and the gilt market
But even sensitivity to some of Burnham's specific plans may have been curbed by two big potential buffers that should allow him both wiggle room and time to pursue his agenda without blowing up the gilt market.
'BORING BUDGETS' AND A POLITICAL IMPERATIVE
First, the Bank of England may have cover to hold off on rate hikes because of moderating inflation pressures, including from the downward reset of the regulatory energy price cap in September. What's more, the BoE is also seeing something very unusual: a drop in UK borrowing.
That relates to Burnham's second lucky break: the legacy of former Chancellor Rachel Reeves. Her tight adherence to fiscal rules that commit to stabilising the country's debt over time may have contributed to the government's poor approval rating, but could also be a gift to her successor because of the comfort they provide investors.
As ING's James Smith pointed out on Monday, this year has already seen a steep £58 billion drop in gilt sales to some £246 billion. That should comfortably cover much of the tax and spend tweaks Burnham has hinted at so far. Indeed, that fiscal shift may even embolden the former Manchester mayor to attempt a more ambitious budget rethink this autumn.
"Britain is a rare example of an economy going through genuine fiscal tightening right now, a consequence of the ongoing freeze in tax thresholds," he wrote, adding there were potentially bigger budget issues Burnham may feel he can tackle soon. These include welfare reform, a property tax review, more defence spending, the unfreezing of tax-free thresholds and potentially switching taxation more to income tax from national insurance payroll tax.
But "a boring budget doesn't win elections," Smith added.
And UK elections matter for markets even more than usual because of the party waiting in the wings.
If a timid Burnham program fails to boost Labour Party poll ratings, then the election chances of Reform UK — the right-wing party now led by Nigel Farage — will only improve — and that moves the balance of risks for investors onto a different plane. Even after Labour's switch of leader, Reform remains slightly ahead of Labour in the most recent polls.
Reform UK would be an unpredictable wildcard for most investors, and many would find it hard not to draw comparisons with the brief, disastrous right-wing Conservative administration of Liz Truss in 2022. Her wild and unfunded "go for growth" budget plan nearly melted down the entire gilt market before she was forced into a U-turn.
And, as the International Monetary Fund outlined this month, the lingering effects of that episode still dog the gilt market to some degree.
The IMF analysis into the elevated UK government bond term premium — or the additional compensation for risks demanded by investors for holding longer-dated debt — showed that the 2022 episode has increased the market's vulnerability ever since. "The September 2022 gilt market turmoil seems to mark a regime shift in how shocks are transmitted into gilt yields," it said, adding it was a major reason for the beefed up term premium.
A Reform UK government could classify as a shock, as could a budget twist from Burnham. Investors have to decide which is better or worse for the bonds they hold.
Fiscal rules and lower borrowing help reassure investors
While you may think that would spook creditors much in the way that Japan's Prime Minister Sanae Takaichi's rise to power from within the ruling LDP late last year upended government bond markets there, that does not appear to be the case. Burnham has helped himself in this regard by committing to the standing fiscal rules and frameworks and concentrating for now on hot-button domestic issues like devolved government, defence, fairness, health and homelessness.
Even though benchmark 10-year British government borrowing rates remain the highest of the G7 nations, they have stayed relatively calm near 5% amid Burnham's spectacularly quick ascent since poor local election results in early May sparked calls for Starmer to step aside. Indeed, sterling has appreciated almost 3% against the euro since then, hitting its best levels against the single currency in over a year last week.
Burnham's surprise announcement on Monday that former defence secretary John Healey would be his finance minister had little immediate market impact, with Shabana Mahmood — who had been widely tipped for the top economic job — remaining interior minister.
Some think that is mainly because the financial ship will likely be steered directly by Number 10 rather than being guided primarily by the Chancellor of the Exchequer next door.
"We retain our view that economic policy is increasingly going to be directed by the prime minister's office, and delivered by the chancellor rather than formulated out of Number 11," Barclays' Jack Meaning and Cian Hennigan wrote late last week.
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