The vaccine may help settle cash flows but inflation remains a risk

Sponsored article: Lauren Sewell of Tradition examines the prospects for long-term borrowing as Brexit settles and vaccines are deployed against Covid-19.

On the 9th October 2019 Whitehall sent shockwaves through the local authority (LA) sector when it announced an overnight 100bp increase to PWLB lending margins, in an effort by the government to kerb what they felt was an inappropriate use, by some authorities, of the low borrowing rates offered to councils.

Treasurers had been patient, with many having borrowed in the short term as they awaited news on the outcome of the consultation. It finally concluded when PWLB outlined its future lending terms for LAs last month, with a new set of borrowing rules aimed at discouraging councils borrowing primarily for yield. The 100bp rise was reversed, for spending which falls within the new guidelines, with councils free again to access cheap money to finance capital programmes in their local areas.

However, with a new list of hoops to jump through in order to secure funds, the process has become more arduous for all.

Vaccine

As well as this, local authorities have had to respond to the Covid-19 crisis and faced what has been among the most uncertain times of our generation. The inter-LA market has always moved separately to the wider UK market, creating its own niche which is highly cyclical and mainly responsive to supply and demand. Covid-19 brought huge unpredictability to what had been a reasonably predictable market. With the reliability of cheap money from the PWLB removed and with huge changes to both income and expenditure happening in a very short period of time, cash flow has been almost impossible to forecast with any degree of certainty.

Nonetheless, with the roll out of both the Pfizer and Oxford/AstraZeneca vaccines, we have found that the general consensus among councils is that they see this uncertainty lifting in the next six months to make way for a clearer path for cash flow and some kind of familiarity returning to the inter-LA market.

With PWLB lending terms confirmed, Brexit agreed and the Covid-19 vaccines being rolled out, many are hopeful for some kind of normality by Spring. Investors in the wider market have taken comfort in the arrival of the vaccines, expecting major economies to lift restrictions and both central banks and governments to keep boosting their economies; with ultra-low interest rates, increased borrowing and Quantitative Easing (QE).

The government will be hoping that Gilt yields stay low as it continues to borrow significantly in the aftermath of Covid. Some investors might suggest that the Bank of England bought an extra £450bn of Gilts during the Covid crisis in order to ease the government’s huge borrowing burden by keeping debt servicing at record lows. But of course the BoE maintains its QE programme is calibrated to keep inflation close to its 2% target.

Negative rate

Speculation continues over whether the Bank could introduce a negative benchmark interest rate to combat the economic hit from the third national lockdown. However, recent comments from the deputy governor of, Ben Broadbent, and money market activity, point to this being less likely.

While inflation currently sits well below the 2% target, a boost in activity as restrictions are eased could lead to a spike in consumer-led inflation, in which case, the BoE may be forced to have another look at interest rates.

However, any interest rate rises to combat inflation, will dampen economic growth. Even a small rise in rates would make increasing debt levels significantly harder to sustain. LA’s long-term borrowing costs are directly linked to Gilts and so they too are exposed to any uptick in inflation. A rise in inflation is in no way guaranteed though, as unemployment may supress wages which in turn would kerb prices.

The vaccine rollout should bring some clarity to cash flows in the near term. However, inflation presents a risk to longer-term borrowing rates and some councils are still keen to explore investment opportunities that don’t fit within the PWLB’s new lending criteria.

Tradition have lenders with an appetite to invest in the local authority sector who not only offer competitive rates, but also a level of flexibility that PWLB simply does not offer. With the ability to access long-term borrowing out of forward start dates, you are able to take uncertainty off the table and we have already had a number of councils explore how these loans can be utilised to forward plan projects and funding programmes.

Lauren Sewell is a broker at Tradition Brokers.
Lauren.Sewell@tradition.com

Photo by Hakan Nural on Unsplash.