Budget: Hostile market response as chancellor suffers Halloween nightmare
First things first: don’t panic.
What you need to know is this. The budget has not gone down well in financial markets. Indeed, it’s gone down about as badly as any budget in recent years, save for Liz Truss’s mini-budget.
The pound is weaker. Government bond yields (essentially, the interest rate the exchequer pays on its debt) have gone up.
That’s precisely the opposite market reaction to the one chancellors like to see after they commend their fiscal statements to the house.
In hindsight, perhaps we shouldn’t be surprised.
After all, the new government just committed itself to considerably more borrowing than its predecessors – about £140bn more borrowing in the coming years. And that money has to be borrowed from someone – namely, financial markets.
But those financial markets are now reassessing how keen they are to lend to the UK.
The upshot is that the pound has fallen quite sharply (the biggest two-day fall in trade-weighted sterling in 18 months) and gilt yields – the interest rate paid by the government – have risen quite sharply.
This was all beginning to crystallise shortly after the budget speech, with yields beginning to rise and the pound beginning to weaken, the moment investors and economists got their hands on the budget documentation.
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Chancellor challenged over gilt yield spike
But the falls in the pound and the rises in the bond yields accelerated today.
This is not, to be absolutely clear, the kind of response any chancellor wants to see after a budget – let alone their first budget in office.
Indeed, I can’t remember another budget which saw as hostile a market response as this one in many years – save for one.
That exception is, of course, the Liz Truss/Kwasi Kwarteng mini-budget of 2022. And here is where you’ll find the silver lining for Keir Starmer and Rachel Reeves.
The rises in gilt yields and falls in sterling in recent hours and days are still far shy of what took place in the run up and aftermath of the mini-budget. This does not yet feel like a crisis moment for UK markets.
But nor is it anything like good news for the government. In fact, it’s pretty awful. Because higher borrowing rates for UK debt mean it (well, us) will end up paying considerably more to service our debt in the coming years.
Rachel Reeves leaving 11 Downing Street before the budget. Pic: PA
And that debt is about to balloon dramatically because of the plans laid down by the chancellor this week.
And this is where things get particularly sticky for Ms Reeves.
In that budget documentation, the Office for Budget Responsibility said the chancellor could afford to see those gilt yields rise by about 1.3 percentage points, but then when they exceeded this level, the so-called “headroom” she had against her fiscal rules would evaporate.
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In other words, she’d break those rules – which, recall, are considerably less strict than the ones she inherited from Jeremy Hunt.
Which raises the question: where are those gilt yields right now? How close are they to the danger zone where the chancellor ends up breaking her rules?
Short answer: worryingly close. Because, right now, the yield on five-year government debt (which is the maturity the OBR focuses on most) is more than halfway towards that danger zone – only 56 basis points away from hitting the point where debt interest costs eat up any leeway the chancellor has to avoid breaking her rules.
Now, we are not in crisis territory yet. Nor can every move in currencies and bonds be attributed to this budget.
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Markets are volatile right now. There’s lots going on: a US election next week and a Bank of England decision on interest rates next week.
The chancellor could get lucky. Gilt yields could settle in the coming days. But, right now, the UK, with its high level of public and private debt, with its new government which has just pledged to borrow many billions more in the coming years, is being closely scrutinised by the “bond vigilantes”.
A Halloween nightmare for any chancellor.
Government borrowing last month was the highest in five years, official figures show, exacerbating the challenge facing Chancellor Rachel Reeves.
Not since 2020, in the early days of the COVID pandemic with the furlough scheme ongoing, was the August borrowing figure so high, according to data from the Office for National Statistics (ONS).
Money blog: Borrowers warned of wider market risk
Tax and national insurance receipts were “noticeably” higher than last year, but those rises were offset by higher spending on public services, benefits and interest payments on debt, the ONS said.
It meant there was an £18bn gap between government spending and income, a figure £5.25bn higher than expected by economists polled by Reuters.
A political headache
Also released on Friday were revisions to the previous months’ data.
Borrowing in July was more than first thought and revised up to £2.8bn from £1.1bn previously.
For the financial year as a whole, borrowing to June was revised to £65.8bn from £59.9bn.
State borrowing costs have also risen because borrowing has simply become more expensive for the government. Interest payments rose to £8.4bn in August.
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Earlier this month: Why did UK debt just get more expensive?
It compounds the problem for Ms Reeves as she approaches the November budget, and means tax rises could be likely.
Her self-imposed fiscal rules, which she repeatedly said she will stick to, mean she must bring down government debt and balance the budget by 2030.
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Tax rises?
Ms Reeves will need to find money from somewhere, leading to speculation taxes will increase and spending will be cut.
“Today’s figures suggest the chancellor will need to raise taxes by more than the £20bn we had previously estimated,” said Elliott Jordan-Doak, the senior UK economist at research firm Pantheon Macroeconomics.
“We still expect the chancellor to fill the fiscal hole with a smorgasbord of stealth and sin tax increases, along with some smaller spending cuts.”
Sin taxes are typically applied to tobacco and alcohol. Stealth taxes are ones typically not noticed by taxpayers, such as freezing the tax bands, so wage rises mean people fall into higher brackets.
Increased employers’ national insurance costs and rising wages have meant the tax take was already up.
Responding to the figures, Ms Reeves’s deputy, chief secretary to the Treasury, James Murray, said: “This government has a plan to bring down borrowing because taxpayer money should be spent on the country’s priorities, not on debt interest.
“Our focus is on economic stability, fiscal responsibility, ripping up needless red tape, tearing out waste from our public services, driving forward reforms, and putting more money in working people’s pockets.”
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