No room for Treasury complacency as UK hit by toxic cocktail of market shifts
No chancellor much likes it when the pound takes a tumble. No chancellor much likes it when the yield on their government debt – the interest rate paid by the state – climbs to historic highs.
When these two things happen on the same day, and in the run-up to a hotly-awaited Budget… well, that’s the last thing any chancellor ever wants to see coming up on their screen. Yet that was the toxic cocktail that awaited Rachel Reeves on the terminal screens in the Treasury on Tuesday morning.
The pound dropped by more than a percent against the US dollar, while the yield on 30-year government debt (known as gilts) rose to the highest level since 1998.
The real question now is: how much does she have to worry about it and, more to the point, what can she do about it?
Let’s start with the first question first. Bond yields are a measure of the interest rate paid on debt and, in the case of government debt, they are influenced by all sorts of things. This makes interpreting their movements quite tricky, at the best of times.
For in one respect, they are a proxy for how creditworthy (or not) investors think a government is. If they think a country is about to default on its debt (Greek bonds and the euro crisis are perhaps the best example) then they might sell a country’s bonds and, lo and behold, the interest rate on those bonds goes up.
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Inflation up by more than expected
But in another respect they also reflect what people think will happen to inflation and interest rates in the coming years (or, in the case of long-dated bonds like the 30-year gilt, the coming decades). So, if you think inflation is going to be higher for longer, then all else equal, you would expect gilt yields to be higher, since that implies the Bank of England will have to keep its interest rates higher. It all feeds into the government bond yield.
Nor is that the end of it, because these yields are also affected by all sorts of other things: how much demand is there from pension funds? What’s the impact of the ageing population? How fast is the country going to grow? All of these things (and more) can have a bearing on the bond yield.
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All of which is to say, there’s rarely a single explanation for phenomena like the one we’ve got today. Consider the higher 30-year bond yields faced by the UK. On the one hand, there’s a compelling explanation served up by the Whitehall and parliamentary drama of recent months.
The government has failed to pass some key legislation cutting welfare spending. It has also had to do a U-turn on cutting winter fuel payments. Those two decisions mean it is left with a sizeable hole in the public finances in the coming years. That in turn makes it considerably more likely that it might have to borrow more, which in turn means investors might be getting more worried about Britain’s indebtedness. That’s totally consistent with higher gilt yields. And so perhaps it’s no surprise that the UK’s 30-year bond yield is considerably higher than other G7 nations.
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But it’s not quite that simple. For one thing, Britain is far from the only country in the G7 with a public finances problem. France and the US have deficit trajectories that look considerably less controlled than Britain’s. Nor is it evident from other measures of fiscal concern – for instance, the credit default swaps insuring against a country going bust – that Britain is an outlier.
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Now consider another datapoint: inflation. Britain has the highest inflation rate in the G7, by some margin. In other words, part of the explanation for the UK’s high yields is that markets are fretting not just about fiscal policy (the stuff done in Whitehall) but monetary policy (the stuff done by the Bank of England in the city).
Now, in practice these two worlds bleed into each other. Part (though certainly not all) of the reason inflation is high is those National Insurance hikes introduced by the Labour government.
In short, this is a bit more complicated than some of the more breathless commentary in recent weeks might have you believe. Even so, regardless of how you balance those explanations, there is no doubting that Britain finds itself in a tricky position.
This combination – of high inflation, weak economic growth and a large and swelling budget deficit – is precisely the economic cocktail that landed the Labour government of the mid-1970s with an IMF bailout. We are a long, long way from anything like that happening this time around. But the ingredients are familiar enough that no one should be altogether complacent.
After all, the last time a government got overly complacent about these factors, back in 2022, we all know what happened next. The mini-Budget, a vertiginous spike in bond yields and a period where Britain’s financial markets stared into the precipice. Best not to repeat that again.
The US ambassador to the UK has said Britain should carry out “more drilling and more production” in the North Sea.
In his first broadcast interview in the job, Warren Stephens urged the UK to make the most of its own oil and gas reserves to cut energy costs and boost the economy.
“Electricity costs are four times ours in the UK, versus the US,” he told Mornings with Ridge and Frost.
“I want the UK economy to be as strong as it possibly can be, so the UK can be the best ally to the US that it possibly can be.
“Having a growing economy is essential to that – and the electricity costs make it very difficult.”
Mr Stephens told Wilfred Frost he hoped Britain would “examine the policies in the North Sea and frankly, make some changes to it that allows for more drilling and more production”.
“You’re using oil and gas, but you’re importing it. Why not use your own?” he asked.
Mr Stephens said Britain should make more of its own oil and gas
The ambassador said he had held meetings with Sir Keir Starmer on the energy issue while US President Donald Trump was in the room, and that the prime minister was “absolutely” listening to the US view.
“I think there are members of the government that are listening,” Mr Stephens told Sky News. “There is a little bit of movement to make changes on the policy and I’ll hope that will continue.”
Energy Secretary Ed Miliband has said the UK should be prioritising net zero by 2030 to limit climate change, rather than issuing new oil and gas drilling licences.
The Thistle Alpha platform, north of Shetland, stopped production in 2020 . Pic: Reuters/Petrofac
However, the ambassador said it would take “all energy for all countries to compete” in the future, given the huge power demands of data centres and AI.
“I don’t think Ed Miliband is necessarily wrong,” said Mr Stephens. “But I think it’s an incorrect policy to ignore your fossil fuel reserves, both in the North Sea and onshore.”
The ambassador hosted Mr Trump on the first night of his second UK state visit in September – a trip that was seen as a success by both sides.
Mr Stephens said Mr Trump and Sir Keir had a “great relationship” and pointed to the historic ties between Britain and the US as a major factor in June’s trade deal and the favourable tariff rate on the UK.
The ambassador said Sir Keir and President Trump have a ‘great relationship’
“The president really loves this country,” the ambassador told Sky News.
“I don’t think it’s coincidental that the tariff rates on the UK are generally a third, or at worst half, of what a lot of other countries are facing.
“I think the prime minister and his team did a great job of positioning the United Kingdom to be the first trade deal, but also the best one that’s been struck.”
Mr Stephens – who began his job in London in May – also touched on the Ukraine war and said Mr Trump’s patience with Russia was “wearing thin”.
The Alaska summit between Mr Trump and Vladimir Putin failed to produce a breakthrough, and the US leader has admitted the Russian president may be “playing” him so he can continue the fighting.
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The ambassador told Sky News he had always favoured a tough stance on Russia and was “delighted” when Mr Trump sanctioned Russia’s two biggest oil firms a few weeks ago.
However, he emphasised the president’s call that other countries must stop buying Russian energy to really tighten the screw.
“The president, has been, I would say, careful in ramping up pressure on Russia. But I think his patience is wearing out,” said Mr Stephens.
“One of the problems is a lot of European countries still depend on Russian gas,” he added.
“We’re mindful of that. We understand that, but until we can really cut off their ability to sell oil and gas around the world, they’re going to have money and Putin seems intent on continuing the war.”
The ambassador also struck a cautious but hopeful tone on future US and UK relations with China.
It comes after Mr Trump said his meeting this week with President Xi Jinping was a “12/10”, raising hopes the trade war between the superpowers could be simmering down.
China’s huge economy is too big to ignore – but it remains a major spy threat; the head of MI5 warned last month of an increase in “state threat activity” from Beijing (as well as Russia and Iran).
Mr Stephens praised the country’s economy and said it would be “terrific” if China could one day be considered a partner.
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But he warned “impatient” China is ruthlessly focused on itself only, and would like to see the US and the West weakened.
“There’s certainly things we want to be able to do with China,” added the ambassador.
“And I know the UK wants to do things with China. The United States does, too – and we should. But I think we always need to keep in the back of our mind that China does not have our interests at heart.”
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Ryanair’s boss has accused the chancellor of having no idea how to grow the UK economy as the airline reported hikes to fares had delivered a 42% rise in half-year profits.
Michael O’Leary told Sky’s Mornings with Ridge and Frost programme that Rachel Reeves “hasn’t the rashers how to deliver growth” while taking aim at a planned rise in air passenger duty slated for next April.
He called for the hike, revealed at her first budget last October, to be reversed in her speech to the Commons on 26 November – a budget business believes could further harm investment in jobs and growth.
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“Until she starts cutting these insane taxes and stop trying to tax wealth, the UK economy is doomed to continue to fail”, he said.
“But, in a bizarre way, that’s probably good for Ryanair’s business because as people get more price sensitive, more and more of them will fly Ryanair,” he concluded.
Mr O’Leary was speaking after the no frills carrier, which is Europe’s largest airline by passenger numbers, reported profit after tax in the six months to the end of September came in at €2.54bn (£2.2bn).
The better-than-expected sum followed a second quarter recovery for fares – the cost of a seat before add-ons – in the wake of a 7% decline across its last financial year.
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Ryanair said revenues per passenger were up 9% over the six months, helped by a 13% rise in fares and higher revenues from additional things like baggage fees and seat selection.
It reported record passenger numbers of 119 million for the half year – the summer season that tends to be the most profitable – and guided that fares, despite some discounting, were on track to end the financial year on a positive footing.
The airline raised its passenger traffic forecast due to earlier-than-expected deliveries of more efficient Boeing aircraft and strong first-half demand.
Ryanair said it expected to fly 207 million passengers in the year to the end of March, up from an earlier forecast of 206 million.
Mr O’Leary told investors: “While Q3 forward bookings are slightly ahead of (PY) prior year, particularly across the Oct. mid-term and Christmas peaks, we would caution that we face more challenging PY fare comps in H2 (second half) making fare growth more challenging”.
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