Have you heard the one about Rachel Reeves and the bond traders? You probably think you have. The Westminster consensus on the chancellor’s credibility goes like this: the markets trust her about as much as they would Juan Perón, Brian Cowen, or, on a good day, Liz Truss. And sure, it’s believable. But right now, although her forthcoming budget is one of the many intractable problems facing this Labour government, her standing in the markets isn’t one of them.
Consider this. Two sets of borrowing figures were published this week. On Tuesday, the Office for National Statistics told us that net public sector borrowing had hit its highest level in five years. That is obviously bad news for a chancellor who tells us there is nothing progressive about spending taxpayers’ cash on servicing government debt. But on Wednesday we learnt that the cost of borrowing is now at its lowest level in a year. The yield on a ten-year UK gilt fell from 4.7 per cent to 4.4 per cent — or 31 basis points — in a fortnight.
Yes, the chancellor knows that borrowing costs have been falling everywhere, and that Britain’s are higher than our G7 competitors. But over the past two weeks, US bond yields have fallen by 16 basis points and Germany’s by 13 basis points. In other words, the UK fall, however modest or transient, can’t be explained away with global trends alone. Someone, somewhere on a trading floor, thinks Reeves is having a good month.
As far as the chancellor is concerned, that something is what she’s been doing all along. Consistency might seem an unlikely compliment to pay her: recall her promise not to come back for more taxes after raising £40 billion of them in last year’s budget. Last week she stood beside a noisy motorway and told Sky News her budget would raise taxes and cut spending. Then she went to the International Monetary Fund’s annual jamboree in Washington and warned the wealthy they should expect to pay more. This was not the line to take last October.
So what hasn’t changed? Reeves always said fiscal responsibility would be her guiding principle, that the sums would always add up, etc, etc. Lots of Labour MPs think this an arid and actuarial way of thinking. To quote the epitaph for Andy Burnham’s abortive leadership challenge: “We’ve got to get beyond this thing of being in hock to the bond market.” As it happens, the bond market likes what it has heard: variations on the old Reeves theme of rectitude and prudence. Park the nightmarish politics for now. The chancellor has said she is willing to confront fiscal reality, and that counts for something in the eyes of the lenders.
Indeed, depending on which ten days the Office for Budget Responsibility decides to take as its snapshot for projected borrowing costs, it could count for as much as £4.5 billion on Reeves’s budget scorecard. In other words, a smaller black hole to fill. Not loads, but very much not nothing. You won’t hear many congratulations for this on Whitehall but Reeves got plenty at the IMF. François-Philippe Champagne, the Canadian finance minister, told her Mark Carney’s Liberal government had modelled its new fiscal rules on hers: tight on day-to-day spending but looser on borrowing for capital investment. Kristalina Georgieva, the IMF managing director, confided in the British delegation that the Canadians had been right to do so.
Whether this helps a deeply unpopular chancellor win the political argument at home is another question. Fiscal choices that satisfy the IMF (all necessary to maintain stability for investors, say advisers to Reeves) might yet enrage the voters. The greatest irony of all is that the markets are likely to breathe a long sigh of relief if she ends up breaking the Labour manifesto’s self-denying ordinance on income tax, national insurance for employees and VAT. For the bond vigilantes that would be the ultimate proof that she means what she says.
Reeves is conscious that the cost of living remains “the number one issue” and has pushed cabinet ministers for policy proposals to bring it down. In this political context — and with UK inflation running higher than the rest of the G7 — it would be pretty deranged if she raised VAT, as much as Treasury officials love to suggest it. Raising income tax, which, unlike national insurance is not solely paid by the “working people” hymned in the Labour manifesto, looks to some economists in the party to be the least worst option — if the chancellor does have to break her word to the electorate to ensure she is still heard by business and the bond traders. Whether Reeves agrees with them remains to be seen.
In the meantime she intends to use the next five weeks, and the budget at the end of them, as a “re-education exercise”. The question she will pose of critics to her left and right is this: what is the alternative?
Despite the warning of cuts to come, Reeves dismisses the notion of another round of austerity. The Treasury expects the savings she does find next month to be likelier to come from Whitehall efficiencies than another big bang of welfare reform. The chancellor has told cabinet colleagues she will not authorise additional spending from their departmental reserves. The OBR’s looming productivity review will blame a lack of investment, as well as Brexit, for the sluggish performance of the UK economy — and downgrade the growth projections too.
It’s a flat “no” to breaking the fiscal rules with more borrowing to fund day-to-day spending too. That’s the one thing guaranteed to reverse any progress Reeves has made with the markets. In the coming weeks she will say, repeatedly, that neither the Tories nor Reform have even begun to reckon with the trade-offs they too would face in government. Sample attack: how does Kemi Badenoch propose to cut £47 billion in spending and slash taxes without reducing spending on schools and hospitals? If Reform can’t balance the books on Kent county council, how can it be trusted with the economy? Nigel Farage, who this month revealed to me that his 2024 manifesto of unfunded tax cuts is in the bin, is confident the big endorsement he’ll unveil from the world of business early next month will offer its own rebuttal.
The political problem is that the electorate and much of the Labour Party can’t bring itself to trust Reeves. Voters hate this young government already and activists are about to endorse Lucy Powell’s demands for a course correction on economic policy and welfare cuts by making her deputy leader. There’s an overwhelming appetite out there for an alternative to this chancellor’s approach. The economic problem is that the bond market currently finds the very thought of that nauseating. We know which path Reeves has chosen. It’s going to be a lonely walk.