Bond crisis leaves Rachel Reeves with nowhere to go
Surging borrowing costs have put the chancellor in a precarious position and Trump policies may cause further trouble
Well, this is awkward. Just months ago Labour swept to victory with a promise to usher in a wonderful new era of extremely boring sensibleness. Out with the clownish, wet lettuce Tories and their car crash economics, in with Rachel “Treasury” Reeves and her menacingly stiff bob. “Stability is the change,” as Keir Starmer inspiringly told a grateful nation.
And now look at what’s happened. Borrowing costs are soaring. They’re higher than when Liz Truss thumbed her nose at bond markets. Long-term borrowing costs are higher than they were just before the financial crisis. The last time His Majesty’s government had to offer investors yields this high, Tony Blair had just taken office and gilt markets were still on their long comedown from Black Wednesday.
It’s looking so bad that all the boffins are already predicting Reeves will have to come crawling back to parliament with more tax rises in the spring, breaking yet another promise (on top of the promise not to raise taxes) that she wouldn’t go around fiddling with fiscal policy all the time.
And thanks to Reeves’s own bill, the Budget Responsibility Act, shoved through parliament within weeks of the election, any fiscal fiddling now requires the Office for Budget Responsibility to produce a full-blown forecast, with charts and slides and lots of chin-stroking showing how utterly awful it all is. Unless, of course, she wishes to make use of the only legal loophole she granted herself, of declaring her measures a “temporary response to an emergency”. This in turn would surely require the chancellor to change her haircut to some kind of Mohican or frazzled professor look, giving the game away completely.
In its extremely lukewarm response to the chancellor’s first budget, the OBR predicted that all her extra spending would raise the cost of government borrowing over time. The yield on five-year gilts (ie the annual interest cost of borrowing for five years) was around 3.8 per cent, which the OBR had forecast would creep up to 4.1 per cent by 2030. The budget, it predicted, would push that up to 4.5 per cent. It turns out this was wildly optimistic. In fact, five-year yields shot over 4.5 per cent yesterday, less than three months after the budget that was meant to bring back sensible.
Reeves’s fundamental mistake was to believe that by demonstrating the proper respect for bond markets she could get everything to go back to normal. She failed to confront the truth that the old “normal” is gone, banished by the Covid borrowing splurge, the return of inflation, the ineptitude of central banks and the can-kicking simply reaching the end of a very long road. The Truss fiasco wasn’t the cause of the change; it was simply the most reckless and destabilising way of revealing it.
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The proximate reasons why we cannot keep the show on the road any more are that our economy is not productive enough to sustain it, the state, in particular, is too inefficient, our population is ageing too quickly and migration is now costing the exchequer money instead of saving it. But looming over these considerable domestic concerns is a larger, even more intractable global problem in the form of US policy.
Starmer and co have plenty of reasons to loathe the Trump administration, but this week’s kerfuffle in gilt markets gave them yet another one. They could argue credibly that it is market anticipation of Trump economic policies that prompted the sell-off in gilts over here. When Reeves unveiled her budget in the autumn, the conventional wisdom was that global interest rates were generally on their way down, thanks to lower inflation and slowing growth. But the conventional wisdom was wrong, especially after the US election. Inflation does not appear to have been tamed as comprehensively as most investors thought and the usual suspects are now convinced that Trump will make it worse by cutting taxes, raising tariffs and deporting millions of migrant workers.
Whether or not this is correct (and such predictions proved wrong last time around), the US continues to suck in stocks of the world’s surplus cash to feed its vast spending on government programmes and consumption. Every other country that similarly relies on a constant inflow of money from elsewhere to finance itself, funded by constantly selling assets like bonds or houses, is in competition for the same cash. And Britain has relied on foreign cash for years. Our rising borrowing costs are an indication that we are having to work ever harder to keep it all going.
How the Trump show plays out is extremely difficult to predict. Based on what happened last time, tariffs seem unlikely to have too much of a malign effect on their own, especially if the US taxes other countries more than it taxes Britain. But there are so many moving parts: what happens to the dollar and what Trump decides to do about it, whether he embraces a radical new approach, like capital controls, how much he cuts taxes, how many workers America needs and how many it gets, what the impact of artificial intelligence is on jobs and growth and, crucially, whether Elon Musk can fulfil his vow to purge the government of wasteful spending.
This last point, perversely, leaves Starmer and Reeves in the position of having to hope their evil billionaire nemesis can pull it off. Every dollar the US can avoid borrowing potentially leaves an extra 80p in the big global lending pot for Britain.
We all know that Reeves isn’t to blame for how the US taxes widgets, but she has certainly played a bad hand very badly indeed. Entering what promised to be a hugely turbulent era, she left herself almost no room for manoeuvre, fiscally or politically, and six months in, has used it all up and more. In opposition she killed off Labour’s plans for green spending and higher welfare. In government she has annoyed pensioners and attacked business. If, after all of this, she can’t even deliver placid bond markets, then even Starmer will be forced to start asking the question: what exactly is Rachel Reeves for?
In long-form interviews before the general election, the chancellor liked to humble-brag about how, in her geeky university days, she had a treasured picture of Gordon Brown on her college room wall. Politely, no one pointed out how those glory days ended, with that plaintive cry in 2008: “It started in America.” As any keen student of Treasury lore could tell you, the line didn’t work for Gordon and, when the time comes, it won’t work for Rachel either.
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