A pledge to shrink the British deficit has sent bond prices sky-high
British Prime Minister David Cameron's coalition government is pushing cuts and austerity measures worth £30 billion ($46 billion) a year to shrink Britain's 11 percent deficit to 2.1 percent by 2015. Chancellor of the Exchequer George Osborne has not spelled out the details—those are to come in a "Comprehensive Spending Review" on Oct. 20. As for the impact of the cuts on ordinary Britons, that won't become apparent until well into 2011.
The bond markets, however, have feasted early on the prospects of a painful budget. Gilts, or government bonds, have returned 2.24 percent in the quarter. U.K. corporate bonds in all currencies have returned 4.97 percent so far this quarter, the best record among the biggest issuers of company debt.
The markets are betting that Cameron's bold moves will preserve Britain's AAA credit rating without slowing the economy so much that it curbs the ability of companies to meet their debt payments. "Investors are happy with the measures taken," says Christian Weber, a senior credit strategist at UniCredit in Munich. "The perception has spread that it's better to actually tackle budget deficits than just keep spending and spending and spending, because that limits your ability in the future to help your economy stabilize."
As the coalition government approaches the moment when the grim details become public, things could get contentious. On Sept. 13 union leaders urged the British public to join millions of workers in a campaign to halt the steep budget cuts. "Industrial action is inevitable unless the government is prepared to change direction," Mark Serwotka, general secretary of the Public and Commercial Services Union, told delegates. A total of 490,000 public-sector jobs will be lost by April 2015 under the measures being planned by Osborne, according to U.K. Treasury estimates.
As long as the coalition of Conservatives and Liberal Democrats holds firm, Cameron and Osborne should be able to push the budget through Parliament. Bond investors are watching carefully: Ten-year gilts have already retreated some from their August highs.
The bottom line: British government bonds have benefited from the draconian budget proposed by the Tories. Protests, however, could be widespread.