The UK's public sector borrowing jumped to GBP 11.2bn in October, the highest October level since 2014. This pushed borrowing year-to-date (April-October) up by 10.3% y/y, to GBP 46.3bn. The uptick in public sector borrowing comes ahead of the 12 December elections, and the manifestos of all leading political parties promise to increase public spending yet further. The Conservative Party manifesto, released over the weekend, shows relatively restrained spending ambitions, of around GBP 2.9bn more per year alongside GBP 3.3bn of tax cuts on average per year until 2023–24. This is a fraction of the GBP 83bn incremental annual spending indicated by the Labour Party. Conservatives are also planning an extra GBP 22bn in investment annually, whereas the Labour Party is promising to lift capital spending from GBP 47bn (roughly 2% of GDP) in 2019-20 to GBP 114bn (roughly 4% of GDP) by 2023-24. Higher capital spending by the new government is likely to lift growth, but also raise the fiscal deficit.

Despite these campaign promises, the bond market response has been muted, with yields on 10-year Gilts still largely range-bound. We don't think they will rise much further over the next 12 months, with markets focusing on the following three factors:

Nevertheless, an unexpected election outcome could weigh on Gilts, although potentially only in the short term. Ten-year government bond yields for France, whose general government gross debt-to-GDP is roughly 98%, stand at –0.05% currently. The UK’s general government gross debt-to-GDP is roughly 85%, while the UK’s budget deficit-to-GDP has narrowed from as high as 10% during the financial crisis to around 2% at present. This suggests a modest rise in deficit alongside economic recovery would likely be tolerated by markets.

Currently, we forecast 10-year Gilt yields to rise to only 0.75% by end-December 2020 from 0.69% at present. An uptick in sovereign yields in the UK could attract greater capital inflows and lend support to the currency and our overall bullish medium- to long-term view on sterling versus the US dollar due to attractive valuations and structural factors. The pound is also still undervalued on a purchasing power parity basis, and we recommend that investors with UK equities in their portfolios do not currency hedge them.