HAMISH MCRAE: Don’t panic, that’s Labour’s job
When a minister tells people not to worry about what’s happening in the financial markets, as Lisa Nandy did on Friday, you know the government is really scared. It should be so.
As Rishi Sunak told a Chancellor colleague, the thing that kept him awake at night was the interest payments the country had to make on its national debt.
Any wiggle room in Rachel Reeves’ budget plans has been wiped out by higher debt costs.
On Friday afternoon, the yield on ten-year government bonds – British government bonds – almost shot to 4.9 percent, the highest level since 2008.
I expect interest rates to rise above 5 percent and unless interest rates fall dramatically in the coming months, the Chancellor will have to break her budget rules, raise taxes or cut government spending.
She cannot do the first because that would further undermine trust in her. The markets already think she is out of her depth.
No joke: all the room in Rachel Reeves’ budget plans has been wiped out by higher debt costs
She cannot do the second, less because she has pledged not to do so, and especially because it would devastate an already struggling economy. So it should be about cuts.
There are superficial parallels with the rise in government bond yields that resulted from the ill-fated budget plans of Liz Truss and her Chancellor Kwasi Kwarteng, but this is fundamentally different.
While Truss’s policies have been seen as an aberration and vice versa, what is happening now is more embedded. Bond yields are rising everywhere on fears that inflation will not fall as quickly as expected, and governments – including the new US one – are increasing their borrowing. Reeves has made matters worse by increasing spending and borrowing, reducing the margin of safety to comply with her rules, and ignoring a warning from the Office for Budget Responsibility that the effect of her plans would be to drive up government bond yields would rise. She didn’t act like that, I was told.
The more disturbing parallel is that of 1976, when the Labor government faced a collapse in confidence in the markets and had to apply for an emergency loan from the International Monetary Fund.
That was when then-Chancellor Denis Healey was heading to the annual IMF meetings – returning to Heathrow due to a crash in the pound on foreign stock markets.
This whole thing is etched in the popular memory of the markets as a classic example of financial incompetence.
Wisely, Reeves has not returned to Heathrow from her planned trip to China this weekend. It would have brought back too many uncomfortable memories. Is it really that bad? Well, not yet. Britain pays a premium over other G7 countries for its borrowing, but we are not facing a buyers’ strike. We can still borrow, at a certain price, to finance the national debt.
The uncomfortable aspect is that government bond yields are rising while sterling is falling. That shows a lack of confidence, because you would normally expect a rise in government bond yields to strengthen the pound, as the higher interest rates would encourage investors to switch to sterling.
Prof. Martin Weale, a former member of the Bank of England’s rate-setting Monetary Policy Committee and someone who understands markets, warned last week that this combination of rising long-term interest rates and a sharp fall in sterling had not happened since 1976.
It is possible that global bond yields will have settled down by March and the rise in inflation will not look too severe. The economy can move on, bloodied but unbowed, because we are a resilient bunch. Reeves’ plans may turn out to pass without a radical return to austerity.
But it is also possible that bond yields will continue to rise, that the pound will remain weak, that inflation will rise, and – although this would be unlikely – the Bank of England’s next rate hike could well be up, not down.
None of us need to panic. But as Lisa Nandy was told, the government is taking the situation in the markets very seriously. It was also about time.
Too bad it didn’t take the markets more seriously when Reeves drafted her budget in October.
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