SerpApi.Org
Markets will not be “hoodwinked” when it comes to borrowing to fund defence, the City has warned John Healey.
Investors said they would see through any attempt to disguise new borrowing as war bonds or efforts to stretch the fiscal rules.
Bond traders instead called on the new Chancellor to fund defence by cutting spending elsewhere.
Matt Amis, an investment director at Aberdeen, which manages more than £340bn, said gilt yields – a measure of UK borrowing costs – would rise if the Chancellor borrowed billions to fund defence.
“It might sound unpatriotic, but defence spending is the same as all other spending. If you’re increasing spending and not looking at the other side of the ledger, then gilt yields move higher,” Mr Amis said.
Conversely, if the Burnham Government cuts spending on pensions and benefits and instead reallocates the money to defence, borrowing costs could fall, he said.
“There’s an environment where the Government scraps things like the triple lock or looks at benefits or anything that really takes down day-to-day spending, but increases spending around infrastructure and defence, and gilt yields fall.”
It comes amid expectations that Mr Healey will boost defence spending after his appointment as Chancellor by Andy Burnham. Mr Healey previously resigned as defence secretary under Sir Keir Starmer’s government in protest against what he saw as underfunding of the Armed Forces.
Mr Healey is supportive of the idea of “war bonds” – debt issued specifically to fund defence spending – and is understood to have discussed the idea with the Prime Minister. However, a No 10 source said on Tuesday it was not something the Government was looking at.
‘A lot more defence spending is needed’
James Athey, a fund manager at Marlborough Investment, said: “It would be slightly naive to believe that investors would be hoodwinked or distracted sufficiently by the label to not recognise that ultimately this was just in gilt issuance with a different name.”
Britain’s borrowing is within touching distance of £3tn, with official figures published on Tuesday showing that the Government has already borrowed more than expected so far this financial year.
The significant debt pile is driving up borrowing costs amid concerns that Britain is on an unsustainable path.
Mr Burnham has suggested he will seek to stretch the fiscal rules he inherited by using more “flexibility”. This would potentially allow the Government to borrow more to fund defence.
However, the comment, made on Monday, prompted a rise in borrowing costs and Lloyd Harris, of fund manager Premier Miton, said: “A lot more defence spending is needed, but it’s needed in conjunction with cut-backs elsewhere, particularly welfare. But that’s not going to happen.
“The suggestion now is that they layer on more debt and more debt interest. Over the longer run, that is unsustainable.”
Kevin Thozet, who sits on the investment committee of French asset manager Carmignac, said Mr Healey’s fiscal headroom was already vulnerable to rising borrowing costs or the economy deteriorating further. Greater borrowing would therefore not be received well.
Mr Thozet said: “Bond markets would not be pleased about this, and I’m not sure that the current setup is giving great confidence as per the sustainability or the trajectory of the UK headroom.”
He added: “We need to see some form of trade-off.”
Mr Healey will struggle to find the money without unpopular decisions, after Sir Keir left a funding gap of £4.7bn as a parting gift for his successor.
Even if he can find this amount, it would still only deliver a £15bn uplift in defence spending – short of what Mr Healey believes is needed.
Mr Amis said: “If you’re increasing spending somewhere, you have to decrease spending somewhere else.”
Mohamed El-Erian, the former chief executive of $2tn (£1.5tn) investor Pimco, said: “The best option that the Government has is to increase defence spending as part of a European effort that would be funded by some type of common bond because that signals that it’s not a UK-specific issue. It’s a much broader issue.”
He added that carefully targeted spending cuts to welfare or pensions would also be a sensible choice.
