Reeves faces a budget storm: bleak outlook for the economy under Labour, says ALEX BRUMMER
When it comes to travel plans for chancellors caught up in market turmoil, it’s a case of being caught between the devil and the deep blue sea.
Staying in Britain is an admission that the markets have you in their sights and are showing weakness. If you continue to honor agreements, there is a risk that you are in the wrong place and that political and financial opponents can strike.
It will be difficult for Rachel Reeves to dispel such thoughts when she heads to China this week.
Leaving aside the political, strategic and human rights aspects of a trip that is unlikely to go down well at Mar-a-Lago, Reeves might want to consider the fate of her predecessors.
In 1976, before the current Chancellor of the Exchequer was born, a heavyweight Labor predecessor Denis Healey returned to Heathrow, on his way to an International Monetary Fund meeting in Manila, as the pound plummeted in the markets.
More recently, in Reeves’ direct view, Kwasi Kwarteng was recalled from Washington to London to be defended after the uncontrolled Truss-Kwarteng mini-Budget was upended by the bond markets.
Failing: Chancellor Rachel Reeves’ £40 billion tax budget has caused a crisis in the public finances
The revolt against Rachel Reeves’ Budget in October was slow. An atmosphere of political crisis has been avoided, but it hangs strongly in the air.
The interest yield on government bonds – gilt-edged shares – has risen explosively. At 4.8 percent, the yield on ten-year government bonds is now higher than at the time of the disastrous Truss tax cuts in autumn 2022.
The yield on thirty-year bonds is at 5.35 percent, the highest level since August 1998.
Truss’s mini-Budget created a crisis for the UK pensions industry, which had foolishly turned the UK’s supposedly safest investment into a complex derivative: liability-based investments (LDIs).
Reeves’s £40 billion tax budget and her increased empowerment of the Office for Budget Responsibility (OBR) have created a crisis in the public finances.
If bond yields remain this high for some time to come, Reeves will be close to breaking her own budget rules within nine months of arriving at the Treasury Department.
The OBR forecasts could require it to raise taxes again or cut spending more deeply.
Reeves’ stewardship of the economy is quickly being undone. Despite a large parliamentary majority designed to buy stability, talking down the economy, high taxes, shifting fiscal rules and a loss of growth momentum have put Britain in the crosshairs of bond watchers.
Questions about U.S. rates and higher-than-expected U.S. interest rates have added to market dissonance.
Capital Economics calculates that higher-than-predicted government bond yields will virtually wipe out the room for additional spending under a mandate to balance daily budgets in 2029-2030.
The picture is further worsened as much of the expected growth for 2025 appears to have disappeared after the economy leveled off in the second half of last year.
Reeves publicly promised only one budget per year. But if she wants to keep the OBR in line, she may have to consider more tax increases or tougher spending deals with government departments.
Higher government bond yields will also hurt ordinary working people and commerce due to the higher costs of fixed-rate mortgages, consumer loans and commercial loans.
The chancellor has so far been helped by goodwill in the city and beyond. The market revolt has not developed into a full-blown crisis that dominates headlines and debate.
Much of the story is hidden from view. The Tories were so battered by their election losses and embarrassed by the economic instability on their watch that they found it difficult to articulate how the positive aspects of their economic legacy have been overcome.
Buoyant growth in the first half, falling inflation and interest rates have been offset by a budget that has battered business confidence, suppressed holiday retail sales and made the likelihood of major bank rate cuts this year less likely.
Added to this is the uncertainty about future relations with Britain’s largest trading partner, the US.
Escaping the clutches of Trump tariffs and pressure to boost defense spending does not make the bleak budget outlook any brighter.
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