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Summary
- We see upside risks to the OBR’s PSNB forecast for 24/25, as well as the DMO’s estimate of CGNCR.
- We expect the BoE can cut more than the market is pricing, but the OBR’s base assumption is even more dovish than this.
- A Labour government from Autumn will mean higher deficit spending. An earlier election will mean this spending will come earlier in the fiscal year.
- The DMO has shifted its intention for issuance towards the shorter buckets, but net-duration supply is likely to rise versus last year on the back of QT.
Market Implications
- We continue to like UK 2s10s steepening, which we have in our model portfolio boxed versus UST 2s10s flattening.
Upside Risks to OBR Deficit Forecast
UK GDP growth has been revised up by forecasters since February, but the UK OBR estimates remain optimistic (Chart 1). If 2024 growth turns out more subdued, it could limit receipt growth.
For the financial year ending March 2024, PSNB was provisionally estimated at £121bn, slightly above the March 2024 OBR forecast but below its forecast from November 2023 (Chart 2). For the financial year ending March 2025, the OBR estimates PSNB lower at £87bn.
Presently, we see upside risk to the 2025/26 PSNB.
For one, the OBR assumes Bank Rate at 4.4% for the fiscal year (approximately, four cuts out to Q4). The market is currently pricing around 4.9%. We sit on the dovish side versus the market (we see 75-100bp cuts this year). But unless something breaks, 4.4% average for the year may be a stretch.
Additionally, the likelihood of a Labour government coming in Autumn will likely put upward pressure on spending into yearend. For now, we expect a late Autumn election is most likely, but if the PM calls one earlier the new government could implement their (likely higher) spending measures earlier.
DMO Skewing Short Term, but Net-Duration Likely Elevated
For net issuance, the DMO estimates CGNCR (central government net cash requirement; the cash deficit, which the DMO issues against) in the FY ending Mar25 at £142bn, roughly where we had estimated in February (Chart 4). As with the PSNB, we now see upside risk to this number.
The updated DMO remit has skewed slightly more towards short- and medium-term issuance – likely to lighten some of the net-duration supply that would otherwise be due (Chart 4).
Despite this, the net supply of duration is likely to remain higher than previous years on the back of the higher CGNCR and elevated BoE QT (Chart 5).
This profile, alongside our BoE dovishness, should keep UK duration underperforming versus the short end (curve steepening). We remain positioned for 2s10s UK steepening in our model portfolio boxed against UST 2s10s flattening.
Henry Occleston is a strategist who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.