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M&G's Leaviss: UK faces its own fiscal cliff within five years

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M&G's bond star Jim Leaviss has warned that while the UK's credit rating downgrade could have happened a lot sooner, it will have little impact on the country's ability to continue to borrow.

Leaviss is far more concerned about a prolonged slide in the price of sterling as the country's fiscal deficit continues to grow and weigh on the anaemic economy, and he warned that the UK could face its very own fiscal cliff crisis within five years without significant extra public spending.

The Euro Stars A-rated manager points out that when the US and France lost their AAA credit rating in August 2011 and January 2012 respectively, while government bond yields fell slightly, it did not affect their ability to borrow from financial markets.

Downgrade does not imply carnage

Leaviss said: 'The downgrade from Aa1 to Aaa does not imply carnage - it counts for around 20 basis points difference in borrowing and it means the government can consider some fiscal stimulus. Lending rates are still low so let’s borrow some money for some infrastructure [projects] and get some growth going.'

He described the UK's AAA credit status as a 'white elephant' in that it was 'a valuable but burdensome gift whose cost far outweighed its true worth' and said that it spelled 'tremendously good news for the UK as it might spark a round of spending'.

'The US is now growing. It did its own fiscal stimulus but the UK didn't. I don't think you can have both debt coming down and growth. Although the [UK] government has talked about spending cuts and tax rises to help growth, so far it has done very little. Around 70% of the planned tax rises have come through, but only 30% of the spending cuts.'

And with spending cuts being pushed further and further back, Leaviss warned that the UK could shortly be in the same debt predicament as the US, but without the sustainable growth factor.

'Spending cuts are being pushed further and further back, and more government departments will need further spending cuts over the next few years. We could face our own fiscal cliff in the next five years.'

Zero exposure to sterling

The M&G Global Macro Bond A USD  manager has been underweight sterling for the past nine months and now has a zero weighting to the UK currency in the fund, with 70% exposure to the US dollar.

'One of the big losers of the downgrade will be George Osborne who put keeping the triple AAA rating at the centre of his policy. [The UK] doesn't look any different to the eurozone. Only Greece Spain and Ireland have higher budget deficits and we are way higher than the other AAA countries, and have even more debt than Italy with its well publicised problems.'

Leaviss also warned that debt to GDP above the 90% ratio could do permanent damage to the UK's growth prospects.

'The UK's debt is now in line with France and a long way away from the old 60% limit agreed at the Maastricht treaty. It is [even further] from the 40% people used to think was the trigger for AAA status.

The fund remains underweight duration because Leaviss sees little value in German and UK ten year government bonds on around 2% yields and he has been increasing his index-linked exposure on the likelihood of further QE in the UK.

'The governments will use inflation as a tool to get their deficits down. Index linked gilts are likely to outperform in this environment and with UK RPI inflation target at 3%,  five year linkers in particular look very cheap at present.'

Ultimately, Leaviss expects virtually every developed world country to lose its AAA credit status.

'The UK is not triple AAA quality and has not been for some time but over the next decade all developed world credit ratings are likely to fall slowly down. Our debt to GDP ratio is well ahead of what we should have as a developed world economy but maybe just one or two countries will be left with AAA-ratings after this sovereign debt crisis - possibly just Australia and Canada.'

He also expects more QE to occur on the view that without it, the Bank of England would be in a serious predicament in terms of a lack of buyers for its gilts.

'Some 30% of the gilt market is owned by foreigners.  If we are not doing any more QE, who is going to be buying the gilts at a time when the country's huge debt needs servicing? We could end up with a crisis of issuance [so] we  think the BoE will have to end up doing more QE.'

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