Introduction
As Andy Burnham’s ascension to the role of Prime Minister draws closer, much of the narrative has focused on the role that bond markets will play in shaping his tenure. In 2022, Liz Truss’ mini-budget triggered market turmoil that eventually removed her from power, highlighting the weight of bonds on British politics. Yet less discussed is the potential fallout that any market destabilisation could have on the broader economy, let alone commercial law.
Why Bonds Matter
Government bonds, known as gilts, are loans taken from private investors, with the government repaying interest over a fixed term. To stimulate the economy after 2008, bonds were issued at a low interest rate. As many of these bonds approach their maturity date, the government has increased yields to finance this.
Currently, government debt to GDP sits at around 95%, while the budget sees around £110 billion spent on debt servicing. This means that any attempt to radically alter government spending results in a loss of trust in gilts. The government is forced to raise rates, increasing long-term costs.
Truss’ mini-budget in the autumn of 2022 saw a series of tax cuts that would result in a £50 billion unfunded ‘black hole’ in British finances, expected to be covered by borrowing. This radical fiscal move only contributed to uncertainty amongst investors about buying new bonds, especially since the move would clash with the Bank of England’s objective of reducing inflation. Consequently, some gilt yields reached their highest level since the 2008 financial crisis.
The Burnham Question
As Mayor of Manchester, Burnham was renowned for his significant increases in public spending to help revitalise the local economy, such as returning the bus network to public control and creating a £1 billion ‘Good Growth Fund’ for investment. It is this ambition that sees him as a popular alternative within the Labour Party. But as aforementioned, the state of British public finances leaves little room for major changes, with the OBR estimating that around £100 billion must be raised to stabilise public debt at 95% from 2030-31 onwards.
How does it affect Commercial Law Firms?
Some businesses looking to raise capital or stabilise finances might issue their own bonds. Government gilt yields often act as a base rate for corporate bonds, as governments are seen as stable alternatives to private entities. What this means is that whenever the government raises the interest on its bonds, corporations will follow, making borrowing more expensive.
This means that businesses will plan spending and borrowing more cautiously. Since these businesses are clients of commercial law firms, their reluctance to pursue deals will reduce firm profits. Transactional practice areas, such as M&A, Private Equity, and Leveraged Finance, are likely to be hit hardest by any bond market turmoil, as the cost and risk of borrowing increases.
Where to watch
In the coming weeks, it is worth watching to see who Burnham will appoint as his chancellor to understand the PM-in-waiting’s fiscal approach better. However, the legal market has anticipated and acted on the decline of British business in recent years, with the most notable observation being the gradual reorientation towards US markets as a focus of growth. Yet, until Burnham’s economic strategy is made clear, there is no telling which way the bond markets will swing for the time being.