It is a mistake to think every twitch in the price of UK government debt is caused by the latest instalment in the great Labour leadership meltdown. Waiting for Wes is not the only drama in town for your average bond vigilante. Resolution – or not – to the Iran conflict is still the bigger story.
Those vigilantes will not be ignoring events in Westminster, obviously. It’s just that there is not yet much to chew on in terms of what it means for fixed-income investors’ daily diet of expectations for inflation, interest rates, growth, borrowing and so on.
What, for example, would an Andy Burnham fiscal rule look like? On one hand, the mayor of Great Manchester has said we need a “strong” one, which seemed to be an attempt to row back on his earlier rash remarks about not wanting to be “in hock” to the bond market. On the other hand, he’s said defence spending could be boosted “outside of the rules”. In the eyes of the market, it’s all spending and the proposed increase would be the critical bit, not the verbal gymnastics beforehand. Until the action gets going (if it does) and addresses specifics, it is hard to draw firm conclusions.
In the meantime, most of the surge in 10-year gilt yields from 4.2% to 5% since early March is explained by the Iran war. Yes, “political uncertainty” is definitely present, as analysts’ calculations of the UK yield premium usually demonstrate. But the greater factor in the past couple of months has been the UK’s painful exposure to higher oil and gas prices, and thus inflationary pressures. Britain imports 40% of its energy and already has some of the highest electricity prices in the western world. “Gilts have been more responsive to moves in energy prices than the political headlines of late,” wrote the thinktank Capital Economics last week, and the same is still true.
None of which means the gilt market would not throw a tantrum if there was a formal contest in which the runners made unfunded spending promises. But all candidates (one assumes) remember the Liz Truss fiasco from 2022 – a prime minister installed in the middle of an unresolved energy crisis, note – and will rein in the rhetoric and commitments.
“The mini-budget casts a long shadow,” wrote the Panmure Liberum chief economist, Simon French, recently. “We believe the checks and balances of financial markets will prove a significant influence on some of the extreme positions that may emerge during any Labour leadership contest.” Quite. The bond market is primed to deliver a kick – but does not expect to have to do so.
And the same checks probably apply after any change of prime minister. It’s no use wishing, as one Burnham-supporting backbencher did this week, that bond markets “will have to fall in line”. The world does not work that way when you want to issue £250bn of gilts this year, your debt-to-GDP ratio is 95% and you’re spending £100bn a year on debt interest. Goldman Sachs’ bland analysis is, depressingly, correct: “Policy choices will remain constrained by the challenging backdrop of rising spending pressures and an already elevated tax burden irrespective of any changes in leadership.”
The scope for a real contest therefore lies in the growth-moving policy ideas now spilling out of Labour-aligned thinktanks. The weighty tome from Labour Growth Group, for instance, is interesting for its call to address economic “scarcities” and its emphasis on making clean electricity cheap, echoing a clamour from the business world. That vital debate would be worth having, but it cannot be said to be raging within the parliamentary Labour party. Instead, the perpetual draw is towards versions of greater EU alignment, where fixes will not be easy or quick, or more public ownership, which the market instinctively distrusts.
“Now is not the time to put our economic stability at risk,” said Rachel Reeves as she brandished a surprisingly strong first-quarter growth rate of 0.6%. The chancellor has a point, never mind the inconsistencies in her economic management in the past two years. It is not obvious where any “battle of ideas”, as Wes Streeting put it in his resignation statement, is supposed to be leading.
The mood in the gilt market looks more baffled than alarmed at this point. But it means a plausible outcome to this crisis is one in which the UK’s “political instability” premium in its borrowing rate – not huge, but rising – simply takes longer to shift. Why are we doing this again?
