Analysis-Britain's growth risks put bond investors on high alert


By Naomi Rovnick and Andy Bruce

LONDON (Reuters) – Britain’s public finances, strained by growing debt and sluggish growth, face a crucial test this month that investors say could prompt another market shock to an economy that is increasingly reliant on fickle foreign funds.

Finance minister Rachel Reeves will deliver an update on the public finances on March 26, based on an assessment by the Office for Budget Responsibility, Britain’s fiscal watchdog.

Reeves says her fiscal rules, which aim to balance day-to-day spending against revenues and reduce public sector net financial liabilities as a share of the economy in future years, are non-negotiable.

But investors fear Britain risks falling into a painful trap in which enforcing those rules – through spending cuts or higher tax – hurts the investment needed to improve long-term growth.

Britain has the biggest current account deficit among advanced economies, bar the United States. And capital flows from the rest of the world have increasingly taken the form of short-term money, rather than stickier forms of capital such as direct investment.

That reliance on short-term capital, which can be pulled away easily in a sell-off, has been greater in Britain than for any other major advanced economy running a current account deficit, Reuters calculations show.

Bank of America strategist Kamal Sharma said Reeves’ fiscal rules risked becoming a target for traders, similar to exchange rate pegs during the late 1990s Asian crisis.

“A big question for many countries is how do you grow your economy to the extent where you can reduce your debt profile? Now the UK is certainly at the forefront on that issue,” said Sharma.

“As the Asia crisis and the recent tumult in the UK and France have shown, markets have tended to gravitate towards some form of notional anchor – be it fixed exchange rates or fiscal rules.”

Felipe Villarroel, partner, portfolio management at TwentyFour, agreed there were some similarities between the UK fiscal rules and a currency peg – even if comparisons with emerging markets were overstated.

“It is a bit dramatic. The UK is still a highly rated sovereign nation,” Villarroel said.

But he added that markets could still test the rule.

“The similarities are having a hard rule that you tell people you are going to abide by no matter what,” he said.

“When the situation evolves and it looks like you will have to break (the rule) then the consequence could be a lot of market volatility.”

Britain’s economy expanded just 0.1% in the fourth quarter of 2024 and output declined unexpectedly in January. The Bank of England last month halved its 2025 growth forecast to 0.75%.



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