Today I want to start by taking you a long way away — in fact, all the way to Sydney, Australia. Why? Because the Reserve Bank of Australia has just raised its main interest rate, the cash rate, by a quarter of a point to 4.35 per cent, citing particularly the inflationary impact of Donald Trump’s reckless war with Iran. My words not theirs.
It is quite a busy time for Australian economic policy. On Tuesday, its treasurer, Jim Chalmers, will present the country’s budget.
I mention this because many headlines have been generated in recent days about the rise in the cost of UK borrowing — the yield on gilt-edged securities (so called because the certificates used to be edged with gold), UK government bonds, which for ten-year gilts has been running at about 5 per cent, and occasionally higher.
If you look at international comparisons, Australian ten-year government bond yields have, for some time, been close to those for the UK, and I think that tells us something. Last week’s interest rate hike has taken us very close to what markets expect the Bank of England to do in the UK, with rate rises priced in from the current 3.75 per cent. This would set the UK apart from most European countries, and certainly those in the eurozone, where the European Central Bank (ECB) has a benchmark interest rate of 2 per cent. In fact, if you regard official interest rates as a base rate, from which other rates in the economy fan out, the UK’s position does not look quite so out of line.
Ten-year gilt yields at 5 per cent are 1.25 percentage points, or 125 basis points, above Bank rate. In Europe, while German bond yields are 100 basis points above the ECB benchmark, those for France are more than 160 points above it, and those for Italy 175. America gets away with a lower premium over the official Federal Funds rate, of about 80 points, because of the so-called exorbitant privilege of being the issuer of the world’s reserve currency.
This is also a useful riposte to the often-heard argument that things must be worse than when Liz Truss was prime minister, because the cost of government borrowing, reflected in gilt yields, is higher. In September-October 2022, however, during the great gilt sell-off that followed the mini-budget, ten-year gilt yields rose to a peak of more than 200 basis points above Bank rate.
Anyway, what has clearly happened in recent weeks is that gilt yields, and government bond yields in other countries, have risen because of the inflationary consequences of the war. In February — when there were hopes of two or three interest rates cuts this year, beginning in March — ten-year gilt yields were as low as 4.2 per cent. Those hopes have now been snuffed out, due to the war.
The UK seems to have been particularly hard hit by this shift. The ECB had pretty much reached the end of its rate-cutting cycle, even before the war; the UK had not.
There is another factor, though. And it is one that, on occasion in recent days, has caused gilt yields to rise in the UK when they have fallen elsewhere. And the reason for that is this country’s political instability.
With every headline suggesting that Sir Keir Starmer is about to be deposed as prime minister by his own party — and there have been such headlines from almost as soon as he took over in July 2024 — the uncertainty and instability is ratcheted higher.
Any suggestion that Rachel Reeves would go with him adds to the fear. She may not have been the most popular chancellor in the world — far from it — but in financial markets, she is seen as a bulwark against fiscal irresponsibility.
The gilt market has been telling us, among other things, that Labour alternatives to Starmer and Reeves would be very risky, and that they are seen as the safest pairs of hands in the party.
If somebody else took over, their first task could be dealing with a gilt market crisis. Potential alternative leaders and chancellors appear to have done no preparatory work; some are even dismissive of the financial markets. Fiscal credibility is hard won, as Reeves has discovered, but easy to lose.
As Simon French, chief economist at Panmure Liberum, the City firm, put it the other day: “Investors with global choices on where they put their capital may not be fans of Starmer or Reeves, but everything I have seen suggests they worry more about who could replace them during the current parliament.”
Whether that stops the coups on this highly political weekend remains to be seen. It will probably not stop the chatter and speculation.
Looking further ahead, the decline of the devils they know — the mainstream political parties — and the rise of fundamentally unserious populist parties, without workable policies or government experience, is also a cause of significant concern to the markets. Government by gimmick does not work.
An extraordinary shift has occurred: at the start of this decade, Labour and the Conservatives had a combined polling support of 80 per cent, sometimes more; now it is less than half that, typically about 35 per cent.
When I mention Reform UK to people in business and in the financial markets, they worry. Even if some admire Nigel Farage’s chutzpah, they fear that his party is a one-man show lacking any depth. When I mention the Greens, they laugh — and not in a good way. But the Labour government has been disappointing, and the Iran war has thrown its “turning the corner” story this year off track.
The Tories are still in a period of political convalescence after 14 years in government. Kemi Badenoch is a feisty leader but has been more successful in landing blows on Starmer than on Farage or Zack Polanski, the leader of the Greens. She is, however, re-establishing her party’s reputation for fiscal responsibility, which sets her apart from the other opposition parties.
Labour and the Conservatives, the grown-up parties, may draw comfort from their combined polling share less than three years ago of more than 70 per cent, and argue that what we are seeing now is an exaggerated example of mid-term protest voting — with a likely return to the mainstream parties as a general election approaches.
Many in business will be hoping that too, because those legendary bond market vigilantes stand ready to pounce, raising the cost of borrowing not just for the government but for everybody else. And, if the ride has been bumpy so far, it could get much, much bumpier.
PS
The big numbers produced by the Office for National Statistics (ONS) generate a lot of coverage, but some of its other figures get missed. It is reducing some of its statistical output to concentrate more on priorities, notably economic data.
One of its Cinderella statistical releases, less covered than others, is its fortnightly Business Insights and Conditions Survey (BICS) — and its latest survey wave, focusing on international trade, is rather interesting.
It found, as you might expect, that 38 per cent of businesses with ten or more employees fear supply chain disruption as a result of war in the Middle East — a sharp increase in supply chain worries compared to the situation just a few weeks ago.
What was also interesting in the latest survey was that just 22 per cent of businesses with ten or more employees have exported goods and services over the past 12 months. In contrast, 28 per cent of them were importers.
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That chimes with the UK’s disappointing export performance since Brexit. Exports of goods and services in volume terms in the final quarter of last year were lower than in the October-December quarter of 2019, the last before Brexit. They were significantly lower than in late 2022, when exports enjoyed a brief post-pandemic flowering.
Imports on the same basis, in contrast, were up by 12 per cent on that pre-Brexit final quarter of 2019, and 6 per cent higher than in late 2022.
There was another interesting finding in the latest survey, however. It was that only 17 per cent of firms have sold to other nations in the UK — what you might call the UK single market (though Northen Ireland is a bit more complicated) — with many citing high transport costs as a problem. That can only have got worse recently.