Bond traders warn against cutting Healey’s fiscal headroom

David Zahn, Franklin Templeton’s head of European fixed income, warned that any attempt to reduce the government’s breathing space would leave it exposed to breaking its spending rules amid one of the most volatile periods for government bonds.

He told CityAM: “Cutting the headroom would not be received well, given the commitment to maintaining it. Lowering the headroom would lead the gilt market to question the UK government’s commitment to longer-term fiscal stability: is this just a one-off adjustment, or the start of further fiscal loosening?”

Mr Healey has caused concern over his reported plans to leave a smaller gap between spending plans and fiscal rules, despite promising a “buffer for uncertainty” when he entered office.

The bond market has been affected by a string of poor government borrowing figures, leaving the Treasury facing a third tax-raising Budget, followed by a combination of the Iran war and a flurry of fresh spending commitments by Prime Minister Andy Burnham.

Economists and analysts warned that the UK was on course for another fiscal consolidation, as speculation increased over sector-specific taxes such as a windfall levy on banks and the gambling industry.

Robert Wood, chief UK economist at Pantheon Macroeconomics, added: “Headroom is also there to give the government a better chance of hitting its fiscal rules and to show markets how the government will ensure public borrowing is on a sustainable path.

“We have to ask, does the government have high confidence that the global bond sell-off is finished here and the risks to energy prices are skewed down rather than up?

“We could easily be back two weeks after the Budget, with the new lower headroom gone. How would that demonstrate the credibility of future consolidation?”

Gilts have been at the sharp end of a global sell-off in government debt, driven by the effect of the conflict in the Middle East on energy prices and by western governments’ deficits.

The Treasury was contacted for comment.