Will Corbyn’s spending plans trigger a crisis?

While economists have expressed concern over potential waste in the Labour party’s plans for a surge in public borrowing for investment, bond investors have shown little support for chancellor Sajid Javid’s claim that there would be “an economic crisis within months”.

The calm in UK government bond markets since Labour last week set out its pre-election plans to borrow to invest — notably in infrastructure — suggests few think the party’s proposals would be difficult to finance given historically low interest rates, even if many think they are not a good idea.

In the 1990s, US Democratic party adviser James Carville said he wanted to be reincarnated as the government bond market because “you can intimidate everybody”, but in Britain’s election campaign it seems that vigilante investors in UK gilts are keeping a low profile.

Both the Conservatives and Labour are promising to borrow more for capital spending, particularly for infrastructure projects such as broadband and transport. It is the first time since the mid 1960s that the two main parties are proposing significant borrow-and-spend prospectuses.

Mark Dowding, chief investment officer at BlueBay Asset Management, summed up the view of many bond investors about the borrowing plans of the Tories and Labour by saying: “The bond market is offering a once-in-a-generation opportunity for a big fiscal expansion.”

Column chart of Public sector net investment in 2022-23 (£bn) showing Labour is proposing a much bigger increase in capital spending than the Conservatives

Mike Riddell, fund manager at Allianz Global Investors, said: “The borrowing figures being floated around [by the Conservatives and Labour] don’t bother me. What is far more important for the gilt market’s prospects is what happens to the global economy, and how the major central banks react.”

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Last week, Mr Javid said public sector net investment would rise from roughly 2 per cent of national income to 3 per cent under new Tory fiscal rules, which would increase capital spending from the current planned level of £51bn in 2022-23 to about £75bn.

But Labour would borrow far more under its plans to take investment to £106bn in 2022-23, or just over 4 per cent of gross domestic product, according to calculations by the Resolution Foundation, a think-tank.

Line chart of Public sector net investment as a % of GDP showing The scale of Labour's investment plans harks back to the 1970s

Labour would potentially borrow more than £106bn so long as the debt was matched by the acquisition of an asset of at least equivalent value — for example, through its plans to nationalise certain industries including energy and water.

However, Labour’s borrowing plans appear less ambitious than the large deficits Japan ran up for much of the past two decades. The US is planning deficits of about 5 per cent of national income over the next five years.

Both the Conservatives and Labour are committed to running a balanced current budget, under which they intend to match day-to-day spending with tax revenues.

Line chart of 10-year UK government bond yield (%) showing The two main parties are looking to take advantage of historically low borrowing costs

The Tories claimed this week that Labour’s spending commitments could total £1.2tn over the next parliament.

The calculation combined estimates for day-to-day spending and investment, and was strongly rejected by Labour. For example, the £200bn price tag put on Labour’s nationalisation plans looks like an overstatement because the party has suggested it would not pay investor compensation based on market rates.

Although the credit rating agency Moody’s put Britain’s Aa2 credit rating on negative watch last week amid concerns that its politicians have become too willing to spend without being ready to raise taxes, it also noted the inherent strengths of the UK economy.

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Moody’s would have to downgrade the UK’s debt another seven notches before stripping gilts of their prized investment-grade status. There have been only two downgrades over the past decade.

And the risk that rises in interest rates would create a sudden UK financing crisis is reduced by how, at 15 years, Britain has the longest maturities on its debt of any leading advanced economy.

John Wraith, head of UK rates strategy at UBS, said: “The UK is much more immune to a bond market shock than most other borrowers. Even if yields doubled overnight, that would take a long time to feed through to borrowing costs.”

Britain’s borrowings were reviewed by the Office for Budget Responsibility in a July report, and although the UK fiscal watchdog noted the possibility of rising interest rates as a crucial risk, it found that a bigger issue was the fact the country has an internationally high proportion of inflation-linked debt.

Most economists agree that borrowing to invest in infrastructure should increase economic growth.

Kallum Pickering, economist at Berenberg Bank, this week raised his short-term forecasts for growth on the prospect of large capital spending by either main party.

But he questioned the case for immediate spending and said the UK would need to embark on so-called supply-side reforms — analysts typically cite regulatory reforms to improve the economy’s efficiency — to raise long-term growth.

“The UK would be better off saving that borrowing capacity for a genuine downturn and instead focus on supply-side reforms and other regulatory measures to improve its competitiveness as it exits the EU,” said Mr Pickering.

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Julian Jessop, economics fellow at the Conservative-leaning Institute of Economic Affairs think-tank, said Labour’s borrowing plans over a five-year parliament should be possible “without necessarily causing major problems”.

But he disputed that Labour could spend the borrowed money efficiently. “When you look at Labour, it’s driven by ideology, and so I have little confidence [the money borrowed] will be well spent,” said Mr Jessop.

Bond investors are also worried about Labour using borrowed money to renationalise energy and water companies.

Mr Wraith said: “Policies like renationalising utilities might put off overseas investors. That could have bigger ramifications than the volume of borrowing itself.”

And some bond investors warned a Labour government would have only a short window to be radical. David Zahn, head of European fixed income at Franklin Templeton, said: “It will take time for the bond vigilantes to come back because a lot of people will chase the yield — but they will come back eventually.”

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