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It hasn’t been a good week for Chancellor Rachel Reeves.
Government borrowing costs rose to a 16-year high and sterling fell to a 14-month low against the dollar.
She made a planned trip to China as opposition parties accuse her of leaving at a time of economic peril.
The Governor of the Bank of England, Andrew Bailey, is accompanying him on his trip. The 12-hour flight to Beijing is probably as long as she could have wanted to have with him.
So how serious are the recent market moves and what could come of them?
Budget plans need fine-tuning
While markets stabilized from midday on Thursday, the move against Britain’s public debt is already enough to pose a problem in the Chancellor’s budget calculations.
Reeves has pledged not to borrow to finance daily expenses and to reduce debt as a percentage of national income by the end of this legislature. The Treasury said these fiscal rules, set out in the budget, are “non-negotiable”.
Over the past week, markets have looked quite fragile for Britain at times, with government borrowing costs rising simultaneously and sterling falling. This is a key marker.
While it is true that the general direction of markets over the past month has been determined by an assessment of the inflationary consequences of President-elect Trump’s trade and economic policies, the United Kingdom has also been the subject of attention particular.
It risks being spoiled by both inflationary rigidity in the United States and stagnant growth in the Eurozone – the worst of both worlds.
That said, it is important to be specific about the scope of the problem. The additional cost of servicing the national debt at these interest rates would amount to several billion pounds per year – that is, large enough to require some sort of correction in the budget calculations, but achievable, and the clear message this week is that “it will be done”. “.
No impact on mortgages so far
The impact on budget calculations is real, but the broader impact that might be expected – higher borrowing costs for businesses and households – has not yet materialized.
The mortgage market has not yet seen an increase in term mortgage rates, as happened quickly during the panic that followed the 2022 mini-budget. There is a curious calm there.
One explanation lies in what is not happening. This time last year, major lenders slashed mortgages in a battle for market share ahead of key home-buying moments. This did not happen this year and could have consequences for the real estate market.
The Bank of England has indicated it will continue its interest rate cuts this year. Markets believe there could be far fewer than expected, perhaps just one, which would leave base interest rates at 4.5%.
Many economists say this is the wrong move and believe rates will be cut multiple times. There is a lot of uncertainty here and the key Bank of England committee is divided. The Bank’s comments will be monitored very carefully.
More positively for the economy, despite much rhetoric from retailers, many have performed well and have not lowered their profit expectations. Are consumers a little more robust than expected, and could this generate some growth in 2025?
Growth strategy needs a reboot
The problem of servicing higher interest on the national debt increases the likelihood that the Treasury will consider an adjustment, based on a spending squeeze. A £10 billion cut would be damaging, but with a majority of 170 MPs in the House of Commons and a current spending review already underway, it can be done.
In these circumstances, faced with the credible threat of a global trade war, for example, it is worth noting that Rachel Reeves’ new fiscal rules do indeed have an escape route.
In the event of an “emergency of a significant negative economic shock to the economy”, the chancellor can “temporarily suspend the budget mandate”.
Even if a global trade war can be called, it would be difficult to suspend a set of “non-negotiable” and “ironclad” rules before they have really taken effect. The rules have not yet been officially adopted and remain a “draft” until the Commons votes to approve them.
It seems very unlikely that this path will be taken, unless there is a very clear economic shock in the coming weeks.
The most important point here is what matters in the markets, that is, whether the UK is pursuing a credible set of policies and a compelling overall strategy.
Labour’s emphasis on stability at all costs was understandable after the humiliation of Liz Truss’s mini-budget. But “stability” is not a growth strategy.
Pursuing green growth by borrowing to invest for the long term is a potential strategy, and it underpins bidenomics in the United States. The new government adopted the rhetoric of the outgoing president’s American policies, but without the same firepower. “Bidenomics without money”, one could say.
But today, the new Trump administration is abandoning this approach, rightly or wrongly, and markets are less convinced that such a strategy will be profitable. Funding such a strategy will cost more and require tougher compromises than expected.
Bidenomy without money and without Biden is far too thin. A more detailed strategy for sustainable growth is needed, and as soon as possible.
