LIVE MARKETS-UK budget expectations are so gloomy, upside surprises beckon - BMO

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UK BUDGET EXPECTATIONS ARE SO GLOOMY, UPSIDE SURPRISES BECKON - BMO

The date has been set. British finance minister Rachel Reeves will reveal the UK's next annual budget on November 26, and the news comes just as UK long-dated bond yields tick up to their highest level since 1998 with traders mulling the country's fiscal challenges.

According to BMO Capital Markets' head of EMEA rates strategy Laurence Mutkin though, gilt markets participants should not lose their cool.

"Expectations for the Budget are so gloomy, there is scope for upside surprises," he writes.

For Mutkin, market rates have done no more than go back to where they should be - they have been recommending short gilt positions.

"...the 10y yield is back at the top of its YTD range, and the forward strip now discounts a much more reasonable terminal rate for Bank Rate of 3.75%-4.0%"

Moreover, the UK does not face problems as worrying as many international peers.

"For all the fretting, consensus GDP forecasts are 1-1.5% or the next 3 years, stocks are +12% YTD, GBP near the top of its post-Brexit range," says Mutkin.

In fact many of the potential bearish scenarios for gilts conceal an offsetting bullish element, he says.

Higher taxes and gilt issuance are widely expected, to address the fiscal shortfall.

"What would be unexpected, and bullish for gilts, would be for the government to return – even modestly – to reducing spending," he flags.

And while supply will remain high, the BoE could reduce QT at its next meeting.

BMO recommends returning to neutral in 10y yields now they have reached and passed their 4.75% target.

As for the curve shape, "10s30s still looks too flat on an international comparison vs the “overhang” of long-term debt, but the BoE could effectively reduce the overhang at its September meeting, so we would not want to be in a steepener in the run-up to that."

(Lucy Raitano)

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