When a Cabinet Minister tells people they should not be worried by what is happening on the financial markets, as Lisa Nandy did on Friday, you know the Government is really scared. It should be.
As Rishi Sunak told a colleague as Chancellor, the thing that kept him awake at night was the interest payments that the country had to make on its national debt.
All the headroom in Rachel Reeves’ Budget plans has been wiped out by higher debt charges.
On Friday afternoon the yield on ten-year gilts – UK Government bonds – shot up almost to 4.9 per cent, its highest since 2008.
I expect yields to go above 5 per cent and, unless they come down dramatically in the next couple of months, the Chancellor will have to break her fiscal rules, increase taxes, or cut public spending.
She can’t do the first, as that would further undermine confidence in her. The markets already think she is out of her depth.
No laughing matter: All the headroom in Rachel Reeves’ Budget plans has been wiped out by higher debt charges
She can’t do the second, less because she has committed not to, more because it would clobber an already struggling economy. So it would have to be spending cuts.
There are superficial parallels with the surge in gilt 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 were seen as an aberration and reversed, what is happening now is more embedded. Bond yields are rising everywhere on fears that inflation will not come down as fast as expected, and governments – including the incoming US one – are going to up their borrowing. Reeves has made matters worse by increasing spending and borrowing, narrowing the margin of safety to meet her rules, and ignoring a warning from the Office for Budget Responsibility that the effect of her plans would be to push up gilt yields. She did not, I am told, like that very much.
The more troubling parallel is with 1976, when the Labour Government faced a collapse of confidence on the markets and had to go for an emergency loan from the International Monetary Fund.
That was the time when then Chancellor Denis Healey was on his way to the annual IMF meetings – and turned back at Heathrow because of a crash in the pound on the foreign exchanges.
That whole business is etched in the folk memory of the markets as a classic example of financial incompetence.
Wisely, Reeves did not turn back at Heathrow from her planned trip to China this weekend. It would have stirred up too many uncomfortable memories. So are things now really that bad? Well, not yet. The UK is paying a premium over other G7 countries on its borrowing, but we are not facing a buyers’ strike. We can still borrow, at a price, to fund the national debt.
The uncomfortable aspect is that gilt yields are moving up while sterling is moving down. That shows a lack of confidence, as normally you would expect a rise in gilt yields to strengthen the pound, as the higher interest rate would encourage investors to switch into 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, by March, global bond yields will have settled and the rise in inflation won’t look too serious. The economy may scramble along, bloodied but unbowed, for we are a resilient lot. It could turn out that Reeves’ plans squeak by without a radical return to austerity.
But it is also possible that bond yields will continue to climb, the pound will remain weak, inflation will surge, and – though this would be unlikely – the next move on interest rates from the Bank of England could be up, not down.
None of us should panic. But, as Lisa Nandy was briefed to say, the Government is taking the situation on the markets very seriously. About time too.
Pity it didn’t take the markets more seriously when Reeves was framing her Budget in October.
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