We analyze potential consequences of new UK fiscal and monetary policy for UK bonds and the wider economy.

Houses of Parliament

Key Points

  • With windfall taxes on energy companies ruled out, we had expected UK national debt to rise to over 100% of GDP in the near term as a result of revisions to fiscal policy, but the outcome of last week’s ‘mini budget’ was higher than expected.
  • The dramatic change in fiscal policy suggests the credit ratings agencies may lower their ratings on UK debt. 
  • We anticipate that volatility in the UK government bond market will remain high for some time.
  • With sterling tanking and core inflation expectations increasing, pressure is on the Bank of England’s Monetary Policy Committee to move further and faster with interest-rate expectations.
  • There must be considerable doubt that these policies (and by implication this prime minister and chancellor) will survive until the end of the fiscal year.


The appointment of Liz Truss as UK prime minister seemed destined to herald a reversal of the previous government’s plans to reduce the country’s budget deficit; instead of a five-year plan to see the national debt fall from about 96% of GDP to around 80%, we expected to see it exceed 100%, at least in the near term, with the total cost exceeding £100bn. What we did not expect were further regressive tax cuts for the highest earners and for companies, taking the estimated total bill over the next five years to £161bn, with precious little detail on if, how or when fiscal discipline would be restored.

Gilt Market Reaction Violent

Market reaction to the energy price-cap measures announced by the new prime minister about two weeks ago, along with expected reversal of tax and national insurance increases brought in by former Chancellor Rishi Sunak, was relatively muted, mainly because it came as no surprise. Arguably, the UK gilt (government bond) market had been pricing in quite a degree of fiscal loosening over recent weeks; August was the worst month for gilt returns since at least 1986 after all, and gilts had been behaving more like Italian bonds.

However, the reaction to the September 23 ‘mini budget’ has been dramatic. The fiscal statement shocked the market, with further unfunded tax cuts for the highest earners, and steeper-than-expected cuts in corporation tax rates. Not only does it add to the debt burden with an uncertain growth payback – the main concern for markets – it also threatens already fragile social cohesion. The side-lining of the Office for Budget Responsibility, which would normally produce an independent assessment of the impact of these measures, and the recent removal of the most senior official in HM Treasury, has further dented investor confidence in UK institutions.

Gilt Prospects Remain Unattractive for Now

A few weeks ago, gilts looked exceptionally poor value to us, given the inflation backdrop, the likely need for extra spending, waning demand from liability-driven investors and overseas buyers, and the imminent start of gilt sales by the Bank of England. Therefore, our stance for flexible bond mandates had been to be broadly shorter in gilts than the respective benchmarks, preferring some overseas government bond exposure. With last week’s fiscal statement heralding even larger-than-expected twin deficits, and confirming even more unorthodox policy, and with a glut of gilt issuance in sight, we believe gilts still lack investment appeal, even at these much higher yields.

Stubborn Core Inflation

UK government measures announced to cap energy prices should reduce headline inflation (by up to 5%), but with the government supporting aggregate demand with its fiscal largesse, and the pound slumping, we could see core inflation remain high, and a more aggressive monetary response. We have also found with other government relief measures that it is easier to give them than to take them away, so we would caution against assuming the cost of capping energy bills will be a ‘one off’, even if recent energy price falls might reduce the cost.

UK Credit Rating under Threat?

The stable outlook on the UK sovereign rating from the major rating agencies was predicated on a path of gradual debt reduction. This radical change of fiscal policy certainly suggests the outlooks will be revised to negative, as a minimum, or we could see the ratings lowered.

Furthermore, as the prime minister did not receive the backing of the majority of her party’s MPs (Members of Parliament) in the leadership ballot, and her victory in the membership vote was not overwhelming, we expected the honeymoon period to be shorter than if she had been heavily endorsed by the party membership. The fiscal statement has just raised the stakes both internally and externally.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice. For additional Important Information, click on the link below.

Important information

Issued by Newton Investment Management North America LLC ("NIMNA" or the "Firm"). NIMNA is a registered investment adviser and subsidiary of The Bank of New York Mellon Corporation ("BNY Mellon"). The Firm was established in 2021, comprised of equity and multi-asset teams from an affiliate, Mellon Investments Corporation. The Firm is part of the group of affiliated companies that individually or collectively provide investment advisory services under the brand "Newton" or "Newton Investment Management" ("Newton"). Newton currently includes NIMNA and Newton Investment Management Ltd. ("Newton Limited").

Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. Statements are correct as of the date of the material only. You should consult your advisor to determine whether any particular investment strategy is appropriate.

Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including NIMNA and (iv) representatives of Newton Americas, a Division of BNY Mellon Securities Corporation, U.S. Distributor of Newton Investment Management North America.

This material is for institutional investors only. This publication or any portion thereof may not be copied or distributed without prior written approval from the firm.

No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment and past performance is no indication of future performance.

Any forward-looking statements speak only as of the date they are made, and are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results could differ materially from those anticipated in forward-looking statements.

Information about the indices shown here is provided to allow for comparison of the performance of the strategy to that of certain well-known and widely recognized indices. There is no representation that such index is an appropriate benchmark for such comparison.

Share