Bloomberg UK PoliticsGilt-y Plea: Why UK Market Turmoil Is a Big Problem for Rachel Reeves
The government's borrowing costs have shot up this week as long-simmering worries over the UK economy appears to have hit a nerve with investors. In a special extended edition of the podcast, we explain why and what the Chancellor can do about it, with our Managing Editor for Foreign Exchange and Rates Rachel Evans, UK government Reporter Joe Mayes, and Bloomberg's Chief UK Economist Dan Hanson. Hosted by Lizzy Burden and Stephen Carroll.
Bloomberg Audio Studios, podcasts, radio news.
The worry with the UK, especially at the moment, is that investors have just lost faith in the UK as a place to put their assets.
Is Rachel Reeves facing a crisis of faith. That's the view of one investor, fund manager Eva son wy at m ANDNG after the market termoil that's hammered the pound and send government borrowing costs soaring. Hello, you're listening to Bloomberg UK Politics. I'm Stephen Carroll and I'm Lizzie Burden.
Today we're going to be bringing you a special extended edition of UK Politics because yet again we find ourselves at a moment when politicians need to pay attention to what's happening on the bond markets. The government's borrowing costs have shot up this week as long simmering worries over the UK economy appear to have hit a nerve with investors. Now, Stephen, there's global context here. Bonds have been selling off elsewhere as well, but the UK does seem to have been hit harder than other places. Maybe then a more important signal, as we'll get to in a moment, is the weakening in the pound. And I've said it before, I will say it again. Markets are the guardrails on democracy.
Is a sound effect for every time that you say that, Lizzie. Look, the speed of the moves has drawn comparison to the Liz trust Many budget in twenty twenty two. This isn't the same situation, but higher borrowing costs are a big concern at a time when the government's borrowing more. The chance has already had to raise taxes to try and make up for some of that. This is a story that's drawing in the worlds of finance, politics and economics, our specialty. I like to think, let's take a listen to some of what's being said about the situation this morning.
What we are seeing in the UK is a train break in slow motion. The pound is getting hammered as well. So this is about the market's pausing and no confidence motion against the UK every single day.
It's unnerving this morning at least to see that this market move yesterday has not calmed down.
Now.
Many are drawing lines to the trust era UK guilt blow up. Some are saying that we're not yet there. Hell risk of a UK having another guilt blow up is definitely looking like it's growing in magnitude.
The problem the UK has, which is a high level of debt which is no longer very cheap to finance like it was in the twenty tens, and a really weak outlook for economic growth, and that combination is going to be difficult for whoever is chancellor.
It is normal for the price and yields of guilts to vary when there are wider movements in global financial markets, including in response to economic data. This is in stark contrast, stark contrast to the negligence, shameful horror of a circus performance at the Conservative Party unleashed on this country when they were in government a few years ago.
That was Chief Secretary to the Treasury Darren Jones speaking in Parliament this morning about the moves you've seen on markets. Before him, you heard the Institute for Fiscal Studies Chief economist Kyle Emerson, and our colleagues covering markets here at Bloomberg, Valerie Title and ven Ram Well.
So now we've brought together some more of our top Bloomberg colleagues to cover the markets, the economics and politics at play. Here were joined by our managing editor for Foreign Exchange in Rates Rachel Evans, our UK Government reporter Joe Mays, and our chief UK economist Dan Hanson. Welcome to you all.
Like our own version of the Avengers, They're all here.
Rachel, I want to start with you. There's been this long string of superlatives that we could apply to the market moves over the past week. Do you want to just put into context what's happened on UK markets, but particularly for government bonds and for the pound.
Yeah.
So, I mean this all really kicked off earlier this week as everybody was kind of returning from the New Year and Christmas holidays. We saw a long term debt cost, those on thirty year bonds rise to the highest since nineteen ninety eight. And this was kind of, you know, sort of around the same time as we had the auction of thirty year debt, which was the UK first bond sale of the year, and it seemed to kind of be this catalyst that then got investors thinking once more about kind of the debt sustainability issues that the UK faces and kind of the fisk burden that's really being kind of pushed to bond investors with all of the debt that the UK government is asking them to take down this year in order to fund their spending plans. So very quickly this kind of escalated. We saw ten year guilts that yield on those rows past two thousand and eight levels. We've seen the pound falling. It's now that the weeke is since November twenty twenty three. So the supernatives keep kind of coming thick and fast. But it's really this kind of backdrop of just you know, how much the government wants to borrow and can they find investors who are willing to take it down? Not at any level it would seem.
Can I just say on days like this it's an absolute nightmare because I get alerts every time someone says burden and my notifications are going crazy. But look, you heard Darren Jones there completely denying that this was anything like the Liz Trust many budget moment.
Is that fair?
It's certainly not there yet.
We are obviously seeing some very interesting sort of size and scopes in terms of these moves, right you know, we are we're back at nineteen ninety eight levels on the thirty.
Eight Yeah, music markets not a.
Great year for the bond markets, and we were at that point in a very different environment. You know, then back in the nine ninety eight we had a very low debt burden and we were starting to kind of bring down interest rates from as high as eight percent. So different situation than now. But yeah, I mean, like when we do get these sort of big superlatives coming through, it does beg the question of whether we're heading into a new trust type crisis. But the thing that seems to be different at the moment is that this is part of a bigger kind of global reassessment of borrowing costs. UK is whilst perhaps the epicenter and the one that's getting the most hammered by these concerns for a variety of factors, we are seeing this happening globally as well. You know, US yields are rising. We saw twenty year debt yields there rise past five percent for the first time in a couple of years yesterday. So this is this is part of a broader picture. And obviously there's a few different factors working behind, not least the incoming Trump administration and just what that is going to mean for inflation rey pressure and the continuance of debt supply globally. That the bond of estas are being asked to buy.
Okay, so this is something that is at a moment within a larger context as well. Let's think about the politics next and go to our UK government reporter Joe Mays. Joe, what are MPs and ministers saying about this? How worried are they about how high the UK government's borrowing casts have risen.
We just heard Darren Jones in House of Problems trying to put on a kind of reassuring tone about how, yeah, they say, market movements happened all the time and governments want to comment on them. There's a brave face being put on it publicly, but clearly there is alarm within the Treasury about what's happening here and why it might mean that Rachel Reeves does have to announce perhaps spending cuts sooner rather than later to trying to fix the UK's fiscal position and you know, give something to the bomb markets to show that they do really care about fiscal credibility, physical sorties. That's where the doubt has arisen, right. The doubt has risen around the size of the boring plans that Rachel Reeves announced at the budget. How little headroom she gave herself against the main fiscal rules. So that's where the kind of the Treasury and the late Party are siteeing at the moment. There's some surprise for back bench labor MPs who perhaps didn't think we were in the realm of having to go for spending cuts of like fairly bullish budget from the Chancellor last year. So I kind of I think everyone's really coming to terms with this and it's kind of hitting people as a bit of a surprise moment, I think.
So don for anyone whose eyes glaze over at the mention of yields and guilts and the bond market, just explain for us why we should care. What effect do higher borrowing costs have on the public finances? How much worse is the picture now compared to back on Monday.
So I mean, just to think about it in really simple terms. The government, we as UK taxpayers, pay tax and the government spends money, and there's a big gap between those two things at the moment, and it's what the government borrows or the fiscal deficit and what the government does. It goes out to financial markets and the financial markets finance that gap for the government and financial markets. Ask for a price of that debt. There is a price for borrowing money. There's a price of money, and that's the yield. That's the interest rate on the government debt, and as Rachel and Stephen and U Lizzie have all said, it's been rising lately, and that is troubling for Rachel Reeves because obviously investors are demanding this premium. They're in demanding this interest rate, and the government has to pay them and that is one of the lines of spending that goes into the fiscal maths. So we're in a situation now where Rachel Reeves, as Joe just said there, she left herself in the budget a pretty small amount of what we call headroom, so that's sort of space against her fiscal target. Guilt yields have risen enough to wipe that headroom out now, so there is a question sort of looking ahead to March the twenty six, which was meant to just be a forecast update, Rachel Reeves has said that she only wants one event each year where tax is spending change. Now looks like she's going to have to do something, whether that's on spending or on tax. We can debate that and that's why this move is so significant. And it's also if you like, a bit of it becomes a bit self fulfilling, doesn't it, Because as interest rate rise, As interest rates rise, the fiscal position becomes more untenable, and so you get this feedback loop and this concern amongst investors.
Rachel, how do investors? How do we become them? Now after what's happened over the past few days that we've heard a bit about the problem. I suppose if we think about what could what does Rachel Reaves need to say or do that's going to restore us some sort of order, I think it's.
Very difficult for this to kind of come from the policy make aside, because I mean, there's only so much that they can really say without showing their hand or ultimately just sort of you know, not telling the truth about what's going to happen. We know how much the government is looking to borrow this fiscal year, that that is not likely to change. So, you know, does she want to come out and say how they're going to fill kind of the gap and how they're going to take the pressure off the bond market by you know, increasing tax revenue or reducing you know, spending going forward, probably not, so that's a pretty big ask. We have seen some of the Treasury officials coming out to sort of make soothing noises about kind of how this is, you know, relatively normal, and indeed we're not seeing sort of some of the liquidity issues yet anyway that we saw back in twenty twenty two. That's a definite difference between now and back then. A lot of the structural weaknesses that we had in the guilt market around pension funds, how they access liquidity, the infamous ld eyes, those are now very much not really around, so we don't have those issues again. If we were to see liquidity issues come back to the fore though, that's the sort of time we might start thinking about whether the Central Bank needs to intervene. They have a few different options for doing that. Whether they have facilities to lend into the market help ease liquidity, whether they directly buy guilts, whether they pause their QT program. These could all be on the table potentially, but we're a long way from having a liquidity crisis and that would prompt such intervention.
Well, then let's break down that QT point quantitative tightening. Why is that making this situation worse.
So during the financial crisis and during the pandemic, the Bank of England bought an enormous number of guilt eight hundred and ninety five billion pounds worth, which is an enormous amount, and they're now selling those back to the market. And there are two bits of and that's what and that's what we call quantitative tightening. So the selling back of guilts to private investors is the idea of quantitative tightening. And there are two bits of it. So the first bit of it is the Bank of England actively selling to the market, and that's the bit that really is the bit that sort of spooks investors a little bit. Though, what I would say this year is that the bank is doing a lot less active quantitative tightening than it has in past years. It's only going to sell back thirteen billion pounds worth of debt to the market, and the reason for that is because there is a lot of debt that we that is maturing, so it's reached the end of its life. The debt is maturing and that money is going back to private bondholders. So there are there are two bits of it. And sort of going to what Rachel was saying, there about what the bank could do. The idea of stopping QT. The sort of marginal impact of not selling thirteen billion pounds worth of guilts to the market would be pretty minimal, to be honest with you, and I just don't think it's something that they would reach for. And I also think Rachel was absolutely right that if you're thinking about where the intervention or what needs to be done to sort this out, where that comes from, it's not It doesn't feel like it sits at the Bank of England's door at the moment, because it's a fact that would be about financial stability. What we're talking about here is fiscal a fiscal issue and that speaks to what we said earlier about potentially tax rises, potentially spending cuts.
That and it's important to kind of rule that out as not being a potential solution to this problem either. Let's go back to Joe May's for for a was a thought around the political side of this. As you've been reporting, the Chancellor, you know, leaning towards spending cuts to try and address this. But how difficult are the political choices now facing her, you know, Dan Hanson, their you know indication that spending right spending cuts may not go far enough.
Yeah, very difficult. I mean even at the budget Richard Reeves Kistama had a pre significant backlash from within their own cabinet and objecting to the spending plans even then. And so if we're saying that Richrie's will have to come back and say we're going to take even more money out of the kind of public spending envelope, that could be very difficult for her. And indeed they'll have to do a lot of work to convince MP's and ministers that that that is necessary. I think that at the budget we had, spending plans are kind of one point three percent increases in public spending in three, four or five years times. Those are very small numbers already, so they're kind of we're reducing from a low base, which makes it even more difficult. So yeah, massive work which reas have to do to bring her party with her on this.
Joe, what's the difference between efficiency, savings, spending cuts and austerity.
That's a very good question. I think that by and large they are all of much of the much news. I think that you know, Darren Jones and the House of Commons just now was characterizing austerity and ideological approach where you reduce public finances, reduce public spending with no concern for the effect on the UK citizen and public services. I think there's anargument there it's a austerity more of an ideological pursuit. But you know, we are very much in this realm of having to talk about where spending could be reduced and call it what we want. That's what this Laid Party I think has to deliver right now. And as we're saying that, given how the public spending plans already quite tight, there might be some skepticism amongst markets if she goes for the public spending lever again, given how difficult that choice is, and the or we might need to see some tax increases to really bring markets with them as well. So you know, the lost difficult choices here for the Chancellor and.
If you set us up beautifully to go back to our guests here in studio as well, Dan Hanson, I mean you've done some calculations on this in terms of what the fiscal headroom looks like now with borrowing cast higher than they were at the start of the week. What have you found and what does that tell you in terms of the policy prescription.
Yeah, so I think I said earlier that the heads so the nine point nine billion pounds worth of headroom that re'ves set aside in the budget that has gone we think the increase in guilt yills since the October budget, So it's not just the most recent move. You have to take account of what the OBR assumed in its forecast and work out sort of if it did its forecast today, what would it say that interest spending would be, And we think it would be twelve billion pounds higher, So essentially she'd be a little over two billion pounds off side. Obviously, chancellors have historically always left headroom against their fiscal targets. Nine point nine billion pounds is a very small amount historically.
Well, she'd say it's more than the Tories left.
They were, she would, And I'd say it's a lot less than that than chancellors of less historically, you'd have somewhere between twenty five and thirty billion pounds normally to sort of give yourself a buffer against shocks exactly like this. This is exactly why you put that headroom aside. It's because you can see out these sort of gyrations not only in markets but also in the economy. Stephen, on your question about how she will respond or how she could respond to this, you know, I think Joe maide a really and I think it's the most important point around this, Around spending cuts and the credibility of going down that route. It seems very unlikely she'll raise taxes to me, just because of what's happened with the employer national insurance contributions. Obviously in the manifesto, income tax rises, employee national insurance, value added tax VAT, corporation tax rises in those are all ruled out, So you've ruled out seventy odd percent of the tax space, and there's obviously been this huge backlash against what you'd done in the budget. So then you go to departmental spending. I mean, you could cut investment spending. That's another option, but obviously you're a government going for growth, so that's completely inconsistent. You can cut departmental spending, but we already know, as Joe's just said there, that it's extremely tight, so cutting it even further you'd have this fiscal fiction argument coming back at you. So that leaves the benefits bill, and that is obviously extremely politically difficult, but it sort of feels to me like, if you're thinking about credibility, there's sort of the political constraints you're dealing with, and obviously benefits will be very difficult, but the market constraints you're dealing with, you know, maybe the benefits bill would be something that the markets would believe more in if you went for that rather than going safe as seems to be the case day to day government spending, which is already looks like it's on a path that can't be delivered. It's just the spending plans are too tight.
Rachel, would you agree with that? Is that going to be what's needed to shift invested perceptions?
I think Dan makes a really good point that it needs to have credibility, and to what degree the market buys kind of those different options, I think, you know, remains to be seen. I think the other thing that's kind of hard to sort of factor into this is just the ability of the market to sort of decide that it's found a solution and move on if there is enough kind of said by the government that indicates where we're you know, going in the direction of finding, you know, a solution. Of some sort. Then you know, other stories come along, things move on. You know, we still have kind of you know, a Trump inauguration later this month. So to me, in many ways, the thing that actually ultimately stops kind of this meltdown may not necessarily be a solution provided by the UK government, given that there are very few out there. There is very hard to see a silver bullet. The best that they can kind of hope for is sort of stemming the tide and kind of trying to reassure people in the short term and hoping the market moves on, which you know, historically it tend to there's a relatively short attention span for the markets on these things. And I think you know, it's worth looking at sort of the situation in France as a sort of interesting kind of recent comparison. We did see, you know, yields, particularly spreads of French debt to their German equivalents blowing out around some of the political upheaval there. But once it's kind of gone through that process, it has tended to then.
Stabilize the gallic shrug. It will all be at.
Those higher levels, right, you know, when they're not going high rug.
Yeah, Yes, exactly exactly.
They're not they're not going away. It's not like, you know, there's nothing to see here, but it's not like something that kind of gets continually worse and worse. And given that we have seen markets already come a very long way, you know, we've seen guilts moving up, you know, yields moving up successively over the recent days, that may be ultimately what kind of puts a flora of this that they've come a long way. There starts to be bargains to look at. People start to think, yeah, actually I can buy it at these levels, and the attention span of the market moves on to something else.
Yeah, I just want to bring you up given that point, and that, as you say, the markets can be fickle and capricious and move on to something else very quickly. I just want to think about something perhaps a bit more underlying in the perspective for the UK economy and the jobs market. We spoke earlier as the Recruitment and Employment Confederation CEO Neil Carberry, and he talked to us a bit about how businesses are perceiving the situation at the moment, given that they did such a kind of concerted effort to engage with business before the election, He says, they now need to listen.
I think there has to be a real opening up on the next year to eighteen months. What are you asking your business and I think being willing to take some of the tough messages about Frankly, if I talk to my members around the country and they talk to their clients, what they're seeing is right now, we just don't have the confidence to move. They need some big signals quickly, and that will has to come from the center of government.
So as Neil Carberry from the Recruitment's Employment Confederation, Joe, I want to go back to you because this is you know, because back to the politics of it, labor did such a kind of job of winning over business before the election. That message has turned very sour. That's a warning there from the labor market, if you will. I mean, how does Rachel Reeves marry that with the very harsh fiscal reality.
Yeah, I mean maybe one of the big criticisms that Rachel Reave's face post budget is that you know, she talks about she wants to be a governor of growth, and yet one of the biggest policies at that budget was an increase to the nation insurance payroll tax, which would direct hit to business and was very much as an anti growth measure. So I think Reeves knows that she is under pressure to change that narrative, bring a bit more positivity and optimism to her kind of economic narrative. And indeed she's planning a growth speech after her China trip where she's going to try and make that case. I think that well, I find so interesting now is that there will come a moment potentially in the Treasury in the coming days, where they might have to think, well, we cannot wait until March twenty sixth to address what's happening on markets. I think Rachel makes a great point about how you know, other things could come to the rescue, but other things could not as well. I think that's why we're a really fascinating political moment where Reeves might have to do something, but we'll have to see what plays out on markets.
Well, Rachel's made the point that in a sense, Rachel Reeves is at the mercy of global markets. Rachel, let me ask you, what is the next catalyst that we should be looking out for that could make guilt yields climb we've got the US jobs report tomorrow. Could that spark another spike?
Yes?
To be clear, yes, and we're certainly seeing that being mentioned in an analyst notes at the moment. I mean, if we're thinking about kind of how sort of the US sort of picture plays out, you know that there is the potential for you know, the FED to need to cut more than the BOE and therefore that could prompt a rally in a US yields that leaves the UK lagging behind and standing out. I think that decoupling, you know, if we do see yields elsewhere stabilized or start to move lower, would be a very concerning sign for the UK. But beyond that, it's really kind of you know, sort of the incoming Trump administration that is putting the emphasis back on fiscal a situation, on inflationary pressures, and to Joe's point, you know, that may be something that basically keeps the UK's problems front and center, because they are really kind of sort of this lightning rod for some of those issues for investors.
Dan on a scale level one to panic where are you today? It doesn't panic, no, but he is he's very good at his dose of realism. So I feel like that, you know, if we take away the excitement and the frath of what's happening on markets, what is your your mood music for the situation, you know, if we're looking at some form of fiscal statement potentially at least an update from the OBR in March.
Oh, that's a good question.
I don't know.
Maybe a five or six, I told you, but you know most stays on a one or two. So it is no. I mean, I think, look, it's it's definitely a moment, of course, of course it is. But is it is it the moment the sort of the comparisons in nineteen seventy six, the comparisons to trust, I just don't feel, you know, I definitely don't feel like I did at the end of twenty twenty two. I can tell you that. I can tell you that right now. And so much of that is about the speed and the scale of the of the change in the move, the move that happened at that time. It's just nothing in terms, nothing like that.
You know.
It's very you know, stealing a lot of what Rachel has said, but very globally driven. It begs the question how much the spending cuts or whatever gets announced can really do for the UK because so much of it is to do with the FED and what the Fed might do. I mean, Lizzie you asked Rachel about you know, what are we looking for in the sort of weeks and months ahead for another catalyst. I think a really important moment will be the Bank of England decision on February the sixth, because I mean, there's so much there. You know, if this sticks, you know, what is the bank going to say? Will they say this is an unwarranted tightening of financial conditions? Will they cut? We think they probably will. The markets still aren't completely convinced of that, but you know it's more probably more likely than not in market pricing, the OBR will. Then, you know, if nothing emergency and the emergency fiscal side comes out, the OBR then takes the yell curve after the Bank of England, or is likely to take the yell curve after the Bank of England meet. So if you've had a shift in yields, then maybe the headroom isn't gone. Maybe it isn't quite as bad as we all expect. And you know, and I think underpinning all of this is if the data, you know, will the data will be the guide to a lot of this, particularly out of the US, but also in the UK, and you know we've got inflation data coming actually on that front, the things probably probably look a little bit, a little bit worse for the Bank of England.
You entered a Sarah note. I was hoping for a note of optimism. Our TVK economis Dan Hans, and thank you very much for joining us, along with our managing editor for Foreign Exchange in Rates Rache Elevens, and our UK government reported Joe Mays. That's it from us for today. If you like the program, don't forget to subscribe, give it five stars that other people can find it on Apple, podcast, Spotify or wherever you listen.
This episode was produced by James Wilcock and our audio engineer, with Shaun Gastamachia. I'm Lizzie Verdon.
And I'm Stephen Carroll. We'll be back with more on Monday. This Here's Bloomberg.
Bloomberg UK Politics listen weekdays at noon on DAB Digital Radio in London.
