Rachel Reeves likes to mention the Liz Truss/Kwasi Kwarteng mini-Budget. Memories of the market chaos it triggered provide her with the perfect excuse to pose as the voice of prudence. With her penchant for consulting with Gordon Brown and pledges of fealty to George Osborne’s OBR, there is no doubt that Kwarteng is not the recent Chancellor she most wishes to initiate.
The Chancellor will therefore be a little concerned that this week’s headlines have a little echo of it. Britain’s gilt yields have rapidly risen ahead of her first Budget at the end of the month, reflecting an increase in our long-term borrowing costs. The yield on ten-year gilts is now higher than before Kwarteng’s mini-Budget, and the widest between British and German yields in over a year.
Are investors worried about what the Budget might hold? The headlines have been filled with reports that Reeves plans to relax her borrowing rules and fiddle with her fiscal formulae to fund increased investment. Having been burnt by Truss’s £70 billion package of tax cuts, the markets are wary of Reeves opting for a similar binge of up to £60 billion.
Claims that this change is long overdue may receive less of a sympathetic hearing than Reeves hopes. Valuing public sector assets and using them to target net worth will likely prove difficult, even if supports claim it is long overdue. Investors are not idiots. If they can see that Reeves is attempting to borrow more, they will demand more for it, however she chooses to fudge her rules.
Moreover, the Chancellor is in a self-imposed bind over how to fund day-to-day spending, something she pledged would be done out of tax revenue alone. She has to square the circle of her various promises: avoiding a return to ‘austerity’, not raising national insurance, income tax, or VAT, not loading more taxes on ‘working people’, and ensuring the Danegeld flows.
The Institute for Fiscal Studies predicts that if Reeves wants to avoid shrinking spending, taxes must rise by £25 billion. Unfortunately for her, each revenue-raising option she picks then welters. A proposed hike on capital gains tax to up to 39 per cent prompts the Treasury to tell her money will be lost. Same with her non-dom proposals. Pension fund raids are out.
Imposing VAT on private school fees can only be spent so many times over. Freezing threshold will raise the most and seems simplest. But remember how well that worked out for Rishi Sunak. Having made such a big deal of listening to the OBR in contrast to Truss and Kwarteng, Reeves cannot just ignore it when it turns around and tells her that her plans will lose the Treasury money.
With her MPs unlikely to be keen on the first Labour Budget in fourteen years being used to pass the spending cuts required to make the hole go away, the Chancellor finds herself in a bind. As such, borrowing costs are rising as more and more investors wonder exactly where the money will come from on October 30th. Is it time to panic? Are we heading for ‘LDI 2: Electric Boogaloo’?
Not quite. Higher yields also reflect an expectation that European rates will be cut to help Germany’s sluggish economy – hence the difference with ours – and a repricing of what investors expect to happen to Britain’s economy as growth has outpaced expectations. Whilst keeping a close eye on the Middle East, we are not enduring anything like the energy shock of two years ago.
Despite market nerves, the first Budget by a female Chancellor is unlikely to see the wholesale market panic triggered by the last to go out under a female Prime Minister. Yields are no higher than they were in July. But over the coming weeks, questions will be increasingly asked as to how Reeves will make her sums add up, especially as the Treasury struggles to implement her pledges.
If there is a way in which Reeves might imitate Kwarteng, it is how she might be treated by her political chief. Like Truss and Kwarteng, Starmer and Reeves appear to work in lockstep. For a government as devoid of purpose as his, she occasionally provides him with a song to sing. Yet this Budget will be essential to re-setting this government’s fortunes, after a difficult few months.
If it bombs – politically, or with the markets, or both – Starmer will blame Reeves. As with Truss sacking Kwarteng, shuffling Reeves from the stage might, in time, become Starmer’s best hope of reviving his government’s fortunes. Unlikely, after October 30th. But the chances that Reeves does not make it to the next election, or even out of the next two years, are higher than you might think.
