This explains what I have been talking about very clearly:

 

• Ambrose Evans-Pritchard

Labour Britain is the new ‘PIGS’ of the global markets

The UK has carelessly exposed itself as the weakest link in the G7 at a perilous moment

Ambrose Evans-Pritchard

Related Topics

• UK economy, 
• Labour Party, 
• Debt, 
• The Budget, 
• Rachel Reeves

09 January 2025 6:13pm GMT

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It is a near certain bet that Sir Keir Starmer will try to defy the bond vigilantes, hoping that global wealth funds will spot a bargain and start scooping up gilts at distressed prices without any need for Labour to change its current destructive course.

He may be lucky, but the international credibility of this Government is already holed below the waterline. A few more days like this week’s rolling debacle will force his hand.

“Financial players think they were taken for a ride by Rachel Reeves in her pre-election charm offensives, and they don’t like it,” said Bernard Connolly, a veteran adviser to hedge funds and central banks, through multiple debt crises.

“Treasury reassurances will not help. The real fear in markets is that there is a vicious circle in which low growth worsens debt problems. They increasingly fear that the Government can’t get a grip. Something needs to happen to change the narrative,” he said.

Feeding Rachel Reeves to the sharks might placate some, but it “might also make them smell blood in the water”, he said. The larger fundamental problem remains.

“This Government seems hell-bent on snatching defeat from every opportunity,” said Marc Ostwald, a bond specialist at ADM. “We were all hoping for stability after the incessant turmoil of the Tories, but it is now clear to markets that Labour don’t know what they are doing.”

The yield on 10-year gilts briefly touched 4.98pc on Thursday, nearing levels last seen in the late 1990s. “Once it slices through the psychological line of 5pc in a situation like this, the next stop can easily be 6pc. We’re not far away from the point when the Bank of England or the Treasury will have to come up with a circuit-breaker,” said Mr Ostwald.

It is no longer credible to argue that the UK is an innocent collateral casualty of the Trump effect and surging US Treasury yields. This country has carelessly exposed itself as the weakest link in the G7 at a perilous moment, just as international capital markets start to choke on the volumes of debt issuance across the world.

The UK has managed to make an even bigger mess of its fiscal reputation even than Emmanuel Macron’s France, which has no real government, no budget, worse debts and runaway fiscal deficits of 6pc of GDP. This is quite a feat.

The former “PIGS” of the eurozone debt crisis – Portugal, Italy, Greece and Spain – have all done better. Italy’s 10-year bond yields are today slightly lower than they were a year ago. They were then trading at the same level as equivalent gilts. As I write, Reeves must pay 130 basis points more than her Italian counterpart to borrow for 10 years.

“That tells you more than anything else what an absolute mess we have got ourselves into, and I don’t see how Labour can easily turn this around,” said Albert Edwards, global strategist for Société Générale.

We cannot keep fooling ourselves that higher borrowing costs chiefly reflect a perkier economy, with less risk of recessionary deflation than the becalmed eurozone. That comforting illusion died when Reeves talked the economy into zero growth with her mischievous black hole.

She kicked business in the teeth and concocted a Budget plan that borrows an extra £142bn over this parliament – and still ends up with a smaller economy and lower real living standards than would have been the case under Rishi Sunak.

It has taken just three months for the Chancellor to lift the toxic “term premium” on British bonds to levels that endanger this country’s long-term debt dynamics.

The widening gilt spread over Italian, French or Spanish bonds is doubly remarkable because the UK has what ought to be an advantage. The Bank of England can intervene at any moment to buy debt and burn speculators.

The European Central Bank is more constrained by the “no bailout” clause of the Maastricht Treaty. It can no longer get away with monetising the debts of southern Europe under the guise of quantitative easing, and it does not have the legal or political power to do so with its new anti-spread tool (TPI) except in extremis.

Yet traders are still betting more heavily against Reeves regardless.

Krishna Guha and Marco Casiraghi, from Evercore ISI, said the gilts sell-off has not yet reached “Liz Truss standards of crazy” but it is becoming serious enough to require an emergency response.

“We think the Bank of England should consider suspending quantitative tightening (reverse QE) if market pressures continue to build over the next few days, with more radical steps to buy gilts outright,” they said.

They warned that it is a dangerous time for sovereign borrowers to court fate because bond dealers everywhere are holding lower inventories than they used to, starving the market of liquidity and inviting spasms of debt stress.

Whether or not the Chancellor meets her fiscal rule is an entirely trivial question.

Global funds could not care less about this arcane British obsession. They care only whether they are being sufficiently rewarded to accept the credit risk of a country issuing £297bn of Treasury debt this fiscal year, and eye-watering sums thereafter, mostly for purposes that do not raise productivity or the UK’s economic speed limit.

Two thirds of extra borrowing is going on fatter pay for Labour’s friends – only a third is going on public investment, the turbo-charged part with a growth multiplier that pays for itself.

Is the yield high enough for a Japanese, Canadian or Saudi investor to justify the inflation risk, currency risk, and economic risk of funding a nation living beyond its means, with a chronic balance of payments deficit near 4pc of GDP, and a net international investment position of minus £1.05 trillion that is run by a political party with no collective experience of the real economic world?

Mr Connolly has a few words of advice from the world of global Big Money: cut corporation tax and freeze both public sector pay and recruitment. Not that he is expecting any such action. “The underlying situation – public finance, current account, productivity, investment, health service – is dreadful. It’s not Argentina territory but a chainsaw would be useful,” he said.

Labour is now hostage to world forces. Donald Trump and Elon Musk may relieve the pressure by slashing spending and tightening US fiscal policy more than markets expect. The Chinese “carry trade” may keep growing, funnelling more of the world’s trapped savings into global credit. Both effects would bring down bond yields for the rest of us.

But Labour has learnt that the Hobbesian hard-knuckled world of 2025 will not extend an unlimited credit line to a self-indulgent class-warfare party that borrows promiscuously to fund consumption, and does profoundly stupid things such as taxing child education and raising the marginal tax rate on small firms to exorbitant levels.

The sooner that Labour recognises the scale of its misjudgements, the more likely it is to earn a second chance.

You should ALL put this writer on your must-read list:

 

MATTHEW SYED

Old Europe is gripped by a delusion. Get real before it’s too late

The West is living in a fantasy land of free money. Our friends watch in horror, our enemies in delight

Matthew Syed

Sunday December 08 2024, 12.01am, The Sunday Times

What will perhaps confound future historians most is how loudly the alarm bells have been ringing. France, the UK and Germany — the great pillars of the old European order — are crumbling. The rest of the world (and I have family and friends in almost every corner, including some of the fastest-growing challenger economies) can see this, is talking about it and is, frankly, astonished by it.

After the collapse of the Scholz coalition, the defenestration of Michel Barnier and the absurdist relaunch of Sir Keir Starmer last week, I noted one wag on X posting: “It’s like witnessing the fall of Rome but with wifi.” Obviously that’s overegging it a bit, but what astounds this commentator observing from inside the edifice, as it were, is how incapable the peoples of old Europe are at even diagnosing the rot, let alone addressing it.

France is a chastening case in point. I listened to a debate featuring three pundits, including a journalist from Le Monde, as they sought to deconstruct the fall of the PM and possible demise of Emmanuel Macron, and it was like an excerpt from Alice’s Adventures in Wonderland. They calmly (and not unintelligently) talked about the constitutional order, polarisation and the rise of “extreme” parties but didn’t seem to grasp or even glimpse the underlying cause of the problems. This has nothing to do with left or right, Macron or Le Pen, the Fifth Republic or popular divisions. The problem is the French people — the demos, if you will.

• How France fell apart: bitter, bloated and blamed on Macron

France, you see, has had governments of left and right and everything in between while delivering policies of stunning consistency for five decades. Since 1974 the state has run fiscal deficits every year. And the reason for this is obvious to everyone except, seemingly, those living inside the dreamworld. It is the settled and immoveable will of the French people to live beyond their means; to enjoy ever-rising welfare, social spending and subsidies while balking at the higher taxes, longer working hours and delayed pensions required to pay for them. The sovereign debt now stands at 120 per cent of GDP.

There is a word for this, and it is what historians such as Spengler and Gibbon sought to convey in their depictions of the dynamics of civilisational decline: delusional. Barnier’s rather anaemic budget plan was merely to reduce this year’s overspend from 6 per cent to 5 per cent of GDP, but even that led to howls of outrage. Parliamentarians — ventriloquising for an electorate, every section of which has drifted into a state of endemic entitlement — offered a resounding “non!”. So the debt will keep rising, the population will keep ageing, the dependency ratio will keep narrowing and we will find out how deep the rabbit hole goes only when the inevitable bond crisis ignites, with potentially calamitous consequences for France, Europe and, if war by that stage is imminent with the revanchist powers, the world.

The UK electorate is, if anything, even more out to lunch. Not unlike the French, we like to blame “useless” politicians, the electoral system or being inside or outside certain trading blocs, but it’s largely a distraction from the fact that voters have become ever more detached from empirical reality; voters who (as polls consistently reveal) demand Scandinavian public services with American levels of taxation, gleaming new energy infrastructure but not in my backyard, new housing while retaining the local right to veto and triple-locked pensions but not the bill. Look at our anaemic growth, frighteningly expensive electricity and debt interest payments soaring above defence expenditure and behold the wonder of democracy. This is the logical consequence of electoral choices — a feature of our system, not a bug.

Germany has the same root problem, albeit with a Teutonic twist. The nation of Bismarckian realism has spent 30 years ripping off America, the nation on which it relies for its defence, while colluding with the nation that most threatens its security: Russia. Successive leaders have embraced this strategic Ponzi scheme because it enabled them to rig growth figures by outsourcing the costs of protection while embracing dependency on cheap Russian gas, which Putin pitilessly weaponised to weaken European resolve against ever more heinous acts of atrocity. The collapse of Scholz’s coalition is not the cause of the problem; it’s a symptom. Like France and the UK, Germany is an old nation (albeit not unified until the late 19th century) that has drifted into a dreamworld.

And this is what the world sees when looking at us: a civilisation that has lost the very qualities that fuelled its rise. Work ethic. Realism. An inspirational future orientation. Today the UK presides over ever-rising numbers of people on incapacity benefit while scarcely debating the (un)affordability of it. Stats from the World Bank a few years ago (albeit disputed) suggest Europe has 10 per cent of the world’s population, 30 per cent of its economy and 58 per cent of social protection spending.

When reading recently about public sector unions proclaiming the “right” to a four-day week despite collapsing productivity (and our enemies working harder and longer), I couldn’t help reflecting on the work of the historian and general Sir John Glubb. In The Fate of Empires, he noted that it was at the moment of peak vulnerability for the Abbasid caliphate in 9th-century Baghdad — after military takeover and looming bankruptcy — that the people demanded a shorter working week.

Looking around the world merely amplifies one’s sense of the creeping unrealism in old Europe. India may be poor and hamstrung by the iniquitous caste system but it is building like crazy and determined to become a dominant power. Vietnam is a one-party state but securing huge inward tech investment and growing faster than England in the 19th century. Poland and Romania have been backwaters for centuries, but they feel their time is coming. You go to these nations and hear people talking not about rights and entitlements but responsibilities and duties — and defence. They are not looking in the rear-view mirror or cowering in simpering guilt about histories long gone but reaching into the future with courage so palpable you can touch it.

I should note three additional points, which space prevents a fuller examination of. Uncontrolled immigration — legal and illegal — has compounded Europe’s problems, but this policy was emphatically not the will of the people. The utter failure to control borders was not an expression of democracy but its greatest modern betrayal — and it will reverberate decades into the future. One also notes the bureaucratic overreach of EU institutions and ever more visible signs of corruption — this, too, cannot be omitted from any analysis of Europe’s travails. Neither can the increasingly brazen offshoring of the super-rich, who leverage the institutional collateral of Europe to secure vast wealth while siphoning off their tax liabilities.

But I hope it’s possible to be aware of those problems, and to think deeply about how to tackle them, while recognising this column’s takeaway point. Old Europe remains a great power and (to my mind) the best place in the world to live, but its people have drifted into a fantasy land from which they — we — must awake or the world will race ahead of us. And we will be left — with our guilt, culture wars and cat videos — wondering how on earth we let it happen.

France is ahead of us (just) in the shaky fiscal position stakes:

 

• Ambrose Evans-Pritchard

France is playing with fire: an IMF bailout is no longer unthinkable

The collapse of the European project’s twin-anchor threatens dramatic consequences for the Continent

Ambrose Evans-Pritchard

Related Topics

• France, 
• Global economy, 
• IMF

27 November 2024 7:00am GMT

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Emmanuel Macron’s ‘grand bargain’ with Berlin has failed Credit: Sarah Meyssonier/Pool/EPA-EFE/Shutterstock

France is pushing its luck. The country has long enjoyed an “exorbitant privilege” within the EU, able to borrow at rock-bottom German rates because it is deemed to be the twin-anchor of the European project.

Markets assume that the EU institutions will always coddle France whatever it does. We may soon find out whether this is a political narrative beyond its sell-by date.

There is a high likelihood that the Barnier government will collapse over the next month without passing a budget, unable to rein in runaway fiscal deficits that subvert the cohesion of monetary union.

“The governability of France is being called into question more than I have ever seen in my lifetime,” said Moritz Kraemer, ex-head of sovereign ratings at Standard & Poor’s.

The risk spread of 10-year French bonds over German Bunds spiked to 83 points on Tuesday, the highest since the eurozone bond crisis in 2012, though that metric does not fully capture the underlying gravity of events.

“The markets are waiting for a credible response but nobody can see where it is going to come from and there doesn’t seem to be any sense of urgency,” said Mr Kraemer, now chief economist at the German Landesbank LBBW.

“The French are playing with fire. Nobody in the markets still thinks that France is still part of the eurozone core. These spreads are a loud and clear warning,” he said.

His words have weight. S&P will decide on Friday whether to downgrade French debt yet further, after cutting the rating to AA- in May.

France is not at any imminent risk of a Greek default crisis, any more than Britain was at risk during the Truss mini-storm. But it is moving into the grey zone.

Mr Kraemer said the European Central Bank may ultimately be forced to intervene, invoking its untested “spread protection tool” (TPI) to buy French debt on the open market. “This could only go on for a couple of months; then there would have to be a proper adjustment,” he said.

This would require combined action by the International Monetary Fund and EU’s bail-out fund (ESM), together imposing the IMF’s usual medicine of spending cuts, tax rises, and harsh reform – if they could even handle a big beast with €3.3 trillion (£2.8 trillion) of public debt.

“It would be really brutal upfront austerity. The politics would be absolutely toxic because the ECB’s president is a former French finance minister,” he said.

Any use of the rescue machinery would require the assent of the German Bundestag, the Dutch Tweede Kamer and the northern creditor states. It is hard to imagine a more explosive political showdown.

The chances that the current French parliament would agree to draconian terms is close to zero. Two prickly animals hold the balance of power: the Left-wing Popular Front, and the Right-wing National Rally. Both defend France’s sacred – and unaffordable – welfare model.

The EU’s Mercosur trade treaty with Latin America adds another stick of political dynamite to the mix. If this treaty is imposed on France against its vehement protest – as seems likely – it risks an emotional rupture between the French people and the EU power structure.

For now there seems to be a widespread assumption that the ECB will suppress French bond yields as it did for Italy over the years. As cynics say, isn’t that why Emmanuel Macron pushed so hard to secure the top job for France’s Christine Lagarde?

But the institution can no longer mop up Club Med debt with no questions asked under the cover of quantitative easing. Post-Covid inflation has made this patently illegal. Any attempt to do so at scale would lead to a knife-fight within the governing council.

The French government understands the risks as the budget deficit hits 6.1pc of GDP this year and heads for structurally higher levels through the 2020s. “If we don’t act, the mechanical dynamic of public spending could push it to 7pc in 2025,” said Laurent Saint-Martin, the budget minister.

Premier Michel Barnier wants fiscal tightening of €60bn – in reality nearer €45bn – in mixed cuts and taxes, warning of a debt trap as interest service costs spiral higher. “Retrenchment is unavoidable, otherwise we are heading straight into a financial crisis,” he said last month.

Yet he cannot even count on the parties of his own loose coalition. His finance minister – a Macron loyalist – has publicly rebuked him for trying to raise taxes. Other Macronistes are acting as if they are in opposition. Party discipline has disintegrated.

The National Assembly has become a seething hotbed of self-promoting potentates pursuing their own power plays. It is an unedifying spectacle.

The government survives on the sufferance of National Rally’s Marine Le Pen, poetic justice after an election manipulated to deprive her 11m voters of genuine franchise.

As Henry Samuel reports from our Paris bureau, Le Pen is threatening to plant the “kiss of death” on the hapless coalition by joining the Left in a vote of no confidence triggered by attempts to force through the budget by decree power.

She has imposed a “red line” over the cost of living. The real reason is that 73pc of her party’s supporters want rid of Mr Barnier, one of the last great gentlemen of modern politics.

Most of Marine Le Pen’s party want rid of Michel Barnier, the last great gentleman of French politics Credit: Dimitar Dilkoff/AFP via Getty Images

Professor Thomas Mayer, ex-chief economist at Deutsche Bank and author of Europe’s Unfinished Currency, said the political foundations of monetary union are coming apart. “The eurozone core is melting down. Markets can see that public finances are out of control and that France is moving into the Italian camp,” he said.

The German economic establishment is splitting into two camps as it watches the soap opera unfold. “The orthodox view is that Germany must stick to sound finances even if it becomes the sole anchor of the euro. At least we will still have a halfway respectable currency,” he said.

“The second view you are hearing more and more is that if others don’t bother, why should we? To hell with it, let’s just get rid of our debt-brake, and if the euro goes down the drain, that’s just too bad. The coalition imploded over this,” said Prof Mayer, now director of the Flossbach von Storch Research Institute.

“What you are seeing in the bond markets is that investors are beginning to doubt whether the German debt-brake will continue,” he said. Danish yields are now 20 points below German yields even though the krone is pegged to the euro. This is unprecedented.

Prof Mayer said the EU had turned into a bureaucratic leviathan that posed an increasing threat to Germany’s fundamental interests.

“Our government is going to have to confront the European Commission head on. It is imposing more and more directives on everything. It is impinging on personal freedoms, on production, on supply chains. It’s simply horrific,” he said.

“I don’t know how long Scandinavians will go along with it, or the Netherlands: they can all see the writing on the wall,” he said.

One thing is absolutely clear: President Macron’s “grand bargain” with Berlin has failed. He came to power in 2017 pledging to restore fiscal probity and make France fit for the euro. This would supposedly unlock German assent for a “Hamiltonian” leap forward: joint debt issuance and a muscular EU treasury with borrowing powers.

“It is dead in the water. There is no realistic constellation of political parties in Germany that would agree to it,” said Mr Kraemer.

France will probably muddle through and avert a full-blown financial crisis for now. But the larger damage is done.

There will be no fiscal union after all. Without that the euro is a chronically unstable construction on borrowed time.