At a meeting in London this week, together with other wealth managers, California-based investment manager Franklin Templeton shares its insights on the impact of the UK’s Autumn Budget, where tax hikes are expected, on UK gilt markets, the economy and investment.

Amidst rising speculation about what this year’s Autumn Budget might hold, David Zahn, head of European fixed income at Franklin Templeton, suggested at a media event in London this week that UK Chancellor of the Exchequer Rachel Reeves might be just tinkering with tax hikes, with no credible plan. Without spending cuts, Zahn said the same would happen again next year, increasing market uncertainty. Other senior wealth and asset management figures thought that Reeves might be able to bolster confidence in public finances – and hence curb bond yields.

Zahn believes that if Reeves had gone ahead with income tax rises, as initially expected, markets would have done well. “Without having a bigger, more credible tax plan, it complicates things, creating uncertainty. She won’t do austerity measures or cut spending so the only thing she can do is increase taxes,” he said.

Personal tax rises are no longer on the cards, with suggestions including a so-called mansion tax (with properties valued above £1.5 million ($2 million) facing a new tax), as well as further changes to inheritance tax, such as changes to gifting rules.

For weeks, economists and pundits have wondered what Reeves might do in terms of tax hikes and other adjustments to close a gap in public finances, which according to some estimates is more than £40 billion. The editor of this publication considers some of the issues, and from an international vantage point, here.

Gilts
The yield on 10-year government bonds, aka gilts, jumped by more than 0.13 per cent to trade at about 4.75 per cent last Friday, after Reeves ditched plans to raise income taxes, making some wealth managers remain optimistic on gilt investing. The cost of UK government borrowing rose by the most in a single day since early July.

However, Zahn is not optimistic about the UK’s gilt market, saying it is too unpredictable. “We need a more credible tax plan. If she did something big on taxes, yields would fall. If she disappoints, yields could rise further to unsustainable levels of about 6 per cent which forces her hand, making her do a secondary budget,” he said.

This week, Luke Hickmore, investment director – fixed income at UK-based Aberdeen Investments, also said a good Autumn Budget would result in yields lowering, which is good news for every UK taxpayer. “Every time yields move higher, the UK’s borrowing costs go higher, which means money has to be re-allocated from paying for vital services to paying for borrowing costs,” Hickmore said. “The average maturity of gilt issuance is getting shorter, potentially raising the Government’s borrowing costs. For investors, gilts will remain a key reference point for interest rates, mortgage costs, and investment returns.”

Meanwhile, Guillaume Rigeade, co-head of fixed income at Paris-headquartered asset manager Carmignac, drew attention to France’s recent experience which offers a cautionary parallel – both economies are learning that fiscal credibility and stability have become a tradable asset once again, with markets ready to punish even modest policy slippage or political noises. "Reeves finds herself stuck between a political rock and an economic hard place. Her goal will be delivering a coherent framework without reigniting volatility. If she’s successful, the long end of the gilt curve could rally. But a budget that feels politically constrained rather than economically grounded would risk reawakening the ghosts of 2022," Rigeade said.

Andrew Wishart, senior UK economist at German-headquartered investment bank Berenberg, said the news that the government has abandoned its plan to raise income tax rates less than two weeks before the budget announcement on 26 November suggests that the Prime Minister and Chancellor do not believe that they have the political strength necessary to survive breaking their manifesto. “The result will be a smaller and messier fiscal tightening that risks this pre-budget media circus being repeated ahead of future fiscal events," he said in a note.

Meanwhile, David Roberts, head of fixed income at Nedgroup Investments, used soft UK economic data earlier in the month to remove his triple weight to gilts added over the summer. ''We were fairly agnostic UK risk and with political challenges likely heading to Budget day; we took advantage of the move and reduced our exposure,” he said in a note. ''The chat of no tax hikes coupled with weak US employment data saw the relationship reverse. Having 'sold' UK, we 'bought' half our position back. That’s pretty much a pure value call, as we remain concerned about short-term politics more than economic fundamentals,” he continued. “We say we run a global fund: UK was less than 5 per cent of duration, now closer to 10 per cent even after the purchase; gilts had a good run but remain highly volatile, with the outlook uncertain.”

In addition, at the London event this week, Michael Browne, global investment strategist at Franklin Templeton Institute, highlighted that investment is forecast to remain weak and unemployment will rise, with business investment intentions still weak. Savings are also high, with the desire to save having risen. “Survey evidence suggests that many households are seeking to rebuild savings, partly due to concerns over increased taxes and job losses, as well as higher savings interest,” he said.

With inflation still quite high, Zahn believes that there will be one or two more interest rate cuts, with possibly one in December. “The UK is in a race with France over who can destroy their country the fastest. France was ahead but now the UK is pulling in front. The difference is that France is in the EU, with the banking of the European Central Bank (ECB). The UK needs to be more aggressive,” Zahn concluded.