2024 UK Budget
UK Budget Key Announcements
The Budget delivered on 6 March 2024 by Chancellor Jeremy Hunt is potentially the last Budget this government announces. Like previous fiscal statements from this Chancellor, measures announced were in line with expectations amid heavy trailing in the press. The strong rally in gilt yields in December had initially opened up a significant amount of fiscal headroom vs. the Autumn statement, however in January much of this quickly reversed as Gilt yields rose. With the headroom constrained, and little appetite to reignite the market turmoil following the unfunded tax cuts announced by Liz Truss and Kwasi Kwarteng in Autumn 2022, the Chancellor faced limited room to manoeuvre without additional spending cuts.
This low fiscal headroom came despite the Office for Budgetary Responsibility (OBR) making some more optimistic assumptions around the economy, with growth for 2024 revised up by 0.1% to 0.8%, and in 2025 up by 0.5% to 1.9%, significantly higher than the current Bank of England (BoE) and third-party forecasts. Should these forecasts prove to be overly optimistic, the next government may face a significant fiscal gap with the gilt remits expected in coming years already historically high.
Source: OBR, March 2024 Economic and Fiscal outlook.
The next two years expected to see record levels of net gilt issuance
Forecasts may not come to pass. Source: BlackRock, DMO, OBR, BoE. Assumes continued pace of quantitative tightening at £100bn p.a. allowing for passive roll off and difference in purchased vs. current prices.
In terms of spending, the largest change had been well trailed in the press and was the cut of 2% to the main rate of National Insurance both for employees and the self-employed. The Chancellor also announced widely expected extensions to the fuel duty cut, a freeze in alcohol duty and changes to Child Benefit thresholds. As well as using much of his remaining fiscal headroom, these changes were funded by changes to the non-domiciled tax regime, changes to furnished holiday lets and multiple dwellings relief, as the Chancellor took the opportunity to deploy potential labour manifesto promises to generate the headroom to fund his tax cuts.
The budget was closely aligned with expectations and the policies leaked to the press in the preceding days, and the resulting market reaction was equally muted. After an initial sell-off, 10y gilts ended the day broadly unchanged vs. the previous day. The important announcements for LDI investors came after the Chancellor sat down.
Impact on the gilt remit
After the budget comes the remit for how much the Debt Management Office (DMO) will need to borrow over the coming fiscal year. This is the last remit with Sir Robert Stheeman at the helm of the DMO, as he is retiring in June 2024 as the CEO after a distinguished service of 21 years in the role. This transition period may have tempered appetite for wholesale changes to the shape of the gilt remit, although there were some subtle changes to shift the gilt remit towards shorter maturities.
Bigger and Shorter: Gilt Remit for FY 2024/2025, £bn
Source: BlackRock, DMO. Data as at March 2024. Bucket definitions; shorts – 3 to 7 years, mediums – 7 to 15 years, longs – 15yrs+.
Apart from the revised Fiscal Year (FY) 2020-2021 remit (where QE offset a large proportion of the issuance) and the initial FY 2021-2022 remit (which was later revised down), this is the largest Gilt remit ever seen. It was also slightly above the consensus expectation based on a survey BlackRock LDI undertook of brokers.
Gilt remit was slightly larger than expected but shift shorter was broadly in line with consensus from banks based on a BlackRock survey
Forecasts may not come to pass. Source: BlackRock, DMO, Panel of 12 Banks. Data as at March 2024.
For FY 24/25 and Average Forecast FY 24/25 an assumption has been made that the unallocated portion of the remit will be split across shorts, mediums, longs and linkers in the same split as the planned issuance.
We continue to see a shift away from long-end gilts into medium gilts. The allocation of longs has reduced from around 22% in FY 23/24 to around 19% for FY 24/25. This was broadly expected.
The mediums bucket has seen an uptick both in absolute terms and in % terms, increasing from 29% in FY 23/24 to 32% for FY 24/25, slightly above consensus. This 7yr to 15yr bucket is likely being favoured, including with the first mediums syndication ever, due to the shifting demand patterns we see for gilts. There is expected to be less pension scheme demand but with increasing demand from bank treasury departments and overseas investors as gilts offer a more attractive yield, both outright and on an asset swap basis. The DMO has been reactive to the evolving supply demand dynamics, indicating a reduction in the need for longer dated gilts - a sentiment which has also been reflected in investor feedback.
We have also seen a reduction in the percentage of index-linked gilts being issued, with a slight reduction from 12% to 11%, but the bigger remit means there is still possibly more to come in absolute risk terms.
What does it mean for supply of risk to the market?
Although the issuance amount is large, the DMO action to shorten the issuance profile will lessen the amount of interest rate risk the market needs to absorb, important at a time when there is also supply coming from the Quantitative Tightening (QT) program operated by the BoE. At the September 2023 BoE meeting the committee voted to review the Asset Purchase Facility annually (APF) annually, and to reduce the stock of UK government bonds by £100 billion (based on originally purchased values) over the period from October 2023 to September 2024, to a total of £658 billion. There is uncertainty about the pace the Bank of England will follow after September 2024.
Despite the DMO skewing issuance shorter, when taken with QT we still expect a very large amount of PV01 to come to the market, we estimate around 10% more in aggregate than in FY 2023/2024. While the high supply to the 7-15yr mediums bucket might make one nervous of yield increases around this part of the curve, we continue to favour curve steepening from here. The extra supply in the mediums bucket reflects where demand has shifted to and with continued headwinds to LDI demand and insurers likely to be selling gilts as they undertake buy-out activity, there is still a lot of net supply of long dated bonds for the market to digest.
Despite the shift shorter in issuance profile a large amount of PV01 is expected to come to the market
Forecasts may not come to pass. Source: BlackRock, DMO, Panel of 12 Banks. Data as at March 2024.
For FY 24/25 and Average Forecast FY 24/25 an assumption has been made that the unallocated portion of the remit will be split across shorts, mediums, longs and linkers in the same split as the planned issuance. Duration of bonds sold in 2024/2025 per bucket assumed to match that of 2023/2024. APF sales assumes £100bn reduction in balance sheet, less passive roll off and allowing for a scaling factor of current bond values vs. purchase price. Splits of APF sales per bucket are assumed to align with the average of the previous two years.
Strong flattening bias since the start of the year
Since the start of the year, as yields rose but expectations for rate cuts were dialled down, we have seen a strong bear flattening of 10s30s Gilts, meaning the 10y gilt yield has increased by a higher magnitude than the 30y gilt yield, leading to a flatter curve. With the factors described above, we could start to see this flattening reverse and a steeper curve re-emerge.
Having steepened significantly throughout 2023 the gilt curve has recently flattened
The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results. Source: BlackRock, Bloomberg. Data as at March 2024. Based on the generic 30y gilt yield – the generic 10y gilt yield.
Inflation supply and demand
Against the uptick in Index-Linked supply in risk terms, we have seen very strong demand in Index-Linked Gilts over the course of February and March 2024. We think this is being driven by schemes recalibrating their liability profiles and their liabilities becoming more sensitive to inflation as it has fallen and moved further from the 5% cap built into many pensions promises. Against a static supply backdrop, Index-Linked Gilts have rallied over 20 basis points from the highs seen in February of this year.
30yr real yields have fallen on the back of strong inflation demand
The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results. Source: BlackRock, Bloomberg. Data as at March 2024. Based on 2052 Index-linked gilt.
However, we have reason to believe this might be short lived. For all the reasons we wrote about back in October 2023, we expect pension scheme demand to remain subdued, with selling pressure from insurers. For this reason, the higher supply of index-linked gilts may require some concession to digest, which may manifest itself in IOTA (the difference between inflation implied by swaps and gilts) moving higher. There is however a chance that the DMO also skews index-linked gilt issuance shorter to mitigate these risks and they will be able to dynamically assess this as the year progresses.
With higher levels of index-linked gilt issuance and muted pension demand IOTA may drift higher
Iota is a measure of relative value between inflation sourced via the government bond market & inflation sourced from the swap market. Positive Iota indicates that government inflation is cheaper relative to swap inflation.
In Summary
- Policy changes announced by Chancellor Jeremy Hunt were closely aligned with policies trailed ahead of the Budget.
- Slightly larger than expected Gilt remit with subtle changes in allocations away from longs and linkers into mediums, where demand has been strong from banks and overseas investors.
- Despite this, the total PV01 due to come to the market is 10% higher than last year and digesting this risk may drive higher longer dated yields and steeper curves.
- The increasing remit size also means more index-linked gilt risk to come to the market, although the DMO has more flexibility to vary this over the year. Could lead to index-linked gilts cheapening vs. swaps.
