Mike Newton is a markets consultant. He previously worked for the Bank of England and in the financial markets, and was the Conservative candidate for Wolverhampton West in the general election.
Could the gilts market be about to have a nasty shock? As a former Bank of England official, with many years of experience of the financial markets, I can see many of the early warning signs of fiscal instability.
Let’s get the elephant in the room out of the way first: the 2022 mini-budget. Its execution was mismanaged and has left Conservatives who want to talk about fiscal issues playing defence. But a historic policy error does not absolve the new Labour government of scrutiny; it is about them now, not us.
The King’s Speech confirmed that Keir Starmer plans to deliver statism, and lots of it. It feels like 1964 or 1974 all over again, albeit without the magic of Harold Wilson’s personal vision and turn of phrase.
To be fair, this is what the electorate demanded: a more redistributive agenda in which the state crowds out the private sector. The public voted for more government, not less.
Labour has a vast, and expanding, network of fiscal obligations to meet from both the explicit and implicit promises made to the coalition that propelled it to power. Its electoral coalition is essentially transactional.
But this costs money, which needs either a higher tax take or more borrowing. The former relies on higher growth – and Labour’s plans for that may not convince the market enough.
The showpiece of its growth plan is an old-school construction boom dressed up as infrastructure and residential investment. It relies on private capital being unlocked through loosening planning restrictions. (As a Tory, I squirm at the irony that its signature move is deregulation.)
No doubt this is a good time to be a British infrastructure provider or homebuilder. However, expect the cost of materials and workers for these sectors, which have finite capacity medium term, to go through the roof in an inflationary vortex. For the rest of the economy, however, it is not evident where growth is going to come from.
There was not even a tiny upside surprise for business in the Speech. Rachel Reeves’s Autumn Statement will likely chip away at enterprise and self-reliance further, perhaps through measures to limit inheritance tax relief for family business pass-on and changes to capital gains tax.
These are essentially niche taxes, so individually not widely visible to the general public and thus carrying little political risk, but their cumulative negative impact on growth will be significant.
The Speech reaffirmed the sanctity of the Office for Budget Responsibility, in the way that the Bank of England’s monetary policy independence in 1997 was a policy sop to reduce the historical borrowing premium Labour always thinks it faces.
However, given that the Civil Service nowadays is perhaps more left-leaning, even with the best intentions the subconscious OBR bias may be to allow Labour more fiscal room, such as with greater deficits. Policy independence may well be more asymmetric than the market would like.
It is no secret that Rishi Sunak’s government was frustrated by the intransigence of the OBR and the Bank on several issues, and there was perhaps a feeling that both institutions could have been more co-operative. (I wrote an article for ConservativeHome last year on the Bank, arguing for more political control.)
Note the new Chancellor has already been jawboning the Bank to cut rates, noting that ‘it would be nice’ if policy rates could come down. The mood music has begun.
The last two inflation prints have been sticky relative to expectations, particularly in services. Closer to home, last week our vet informed us that he was moving to Australia for a 40 per cent premium on his basic plus guaranteed bonus of ten per cent.
He is only 28, Dudley born and bred, and UK-trained. I see few signs of inflation staying low when anecdotes like this slap you across the face.
The bond market has not yet grasped the structural shift in the macro environment, partly because the Chancellor worked so hard to roll the pitch in advance of the election. But when health and teaching unions are demanding 5.5 per cent pay increases, with inflation at two per cent and with no productivity gains to pay for it, there is a problem.
These unions paid for Labour’s election campaign: perhaps the nationally-funded direct mail on D-Day or Partygate that dropped through your door, or the peppy, irritating adverts on YouTube. One cannot blame them for seeking a quid pro quo. Vast numbers of backbenchers without jobs or other patronage are also a problem: none of them were elected on a platform of free market economics, but rather to defend public services and benefits at all costs.
Thus Reeves has limited political room to always say no. It will be a lot easier to roll back the commitment to increase defence spending to 2.5 per cent of GDP, to empty jails rather than build new ones, and to increase taxation rather than save money through incentivising the 9.4 million economic inactive Britons aged 16-64 into work or reducing NHS bureaucracy.
A combination of low growth and sticky inflation (so-called ‘stagflation’) is never positive for gilts. The large number of mouths that Labour needs to feed will grow no smaller – and given that global bond yields often move in alignment, the prospect of a Donald Trump boom in the US makes it likely that the long-term cost of borrowing is going a lot higher in the coming years.
I have often felt that the price of money is the key to political power. It has always surprised me how few others think this. But it seems evident that when the rate of interest is low and stable, then an incumbent government enjoys a substantial political tailwind, and vice-versa.
The British political experience since the exit from the Gold Standard has been that major turning points in the fortunes of parties are marked by crises that sees interest rates rise rapidly. Labour may be about to experience a dose of this far quicker than it anticipates.
Mike Newton is a markets consultant. He previously worked for the Bank of England and in the financial markets, and was the Conservative candidate for Wolverhampton West in the general election.
Could the gilts market be about to have a nasty shock? As a former Bank of England official, with many years of experience of the financial markets, I can see many of the early warning signs of fiscal instability.
Let’s get the elephant in the room out of the way first: the 2022 mini-budget. Its execution was mismanaged and has left Conservatives who want to talk about fiscal issues playing defence. But a historic policy error does not absolve the new Labour government of scrutiny; it is about them now, not us.
The King’s Speech confirmed that Keir Starmer plans to deliver statism, and lots of it. It feels like 1964 or 1974 all over again, albeit without the magic of Harold Wilson’s personal vision and turn of phrase.
To be fair, this is what the electorate demanded: a more redistributive agenda in which the state crowds out the private sector. The public voted for more government, not less.
Labour has a vast, and expanding, network of fiscal obligations to meet from both the explicit and implicit promises made to the coalition that propelled it to power. Its electoral coalition is essentially transactional.
But this costs money, which needs either a higher tax take or more borrowing. The former relies on higher growth – and Labour’s plans for that may not convince the market enough.
The showpiece of its growth plan is an old-school construction boom dressed up as infrastructure and residential investment. It relies on private capital being unlocked through loosening planning restrictions. (As a Tory, I squirm at the irony that its signature move is deregulation.)
No doubt this is a good time to be a British infrastructure provider or homebuilder. However, expect the cost of materials and workers for these sectors, which have finite capacity medium term, to go through the roof in an inflationary vortex. For the rest of the economy, however, it is not evident where growth is going to come from.
There was not even a tiny upside surprise for business in the Speech. Rachel Reeves’s Autumn Statement will likely chip away at enterprise and self-reliance further, perhaps through measures to limit inheritance tax relief for family business pass-on and changes to capital gains tax.
These are essentially niche taxes, so individually not widely visible to the general public and thus carrying little political risk, but their cumulative negative impact on growth will be significant.
The Speech reaffirmed the sanctity of the Office for Budget Responsibility, in the way that the Bank of England’s monetary policy independence in 1997 was a policy sop to reduce the historical borrowing premium Labour always thinks it faces.
However, given that the Civil Service nowadays is perhaps more left-leaning, even with the best intentions the subconscious OBR bias may be to allow Labour more fiscal room, such as with greater deficits. Policy independence may well be more asymmetric than the market would like.
It is no secret that Rishi Sunak’s government was frustrated by the intransigence of the OBR and the Bank on several issues, and there was perhaps a feeling that both institutions could have been more co-operative. (I wrote an article for ConservativeHome last year on the Bank, arguing for more political control.)
Note the new Chancellor has already been jawboning the Bank to cut rates, noting that ‘it would be nice’ if policy rates could come down. The mood music has begun.
The last two inflation prints have been sticky relative to expectations, particularly in services. Closer to home, last week our vet informed us that he was moving to Australia for a 40 per cent premium on his basic plus guaranteed bonus of ten per cent.
He is only 28, Dudley born and bred, and UK-trained. I see few signs of inflation staying low when anecdotes like this slap you across the face.
The bond market has not yet grasped the structural shift in the macro environment, partly because the Chancellor worked so hard to roll the pitch in advance of the election. But when health and teaching unions are demanding 5.5 per cent pay increases, with inflation at two per cent and with no productivity gains to pay for it, there is a problem.
These unions paid for Labour’s election campaign: perhaps the nationally-funded direct mail on D-Day or Partygate that dropped through your door, or the peppy, irritating adverts on YouTube. One cannot blame them for seeking a quid pro quo. Vast numbers of backbenchers without jobs or other patronage are also a problem: none of them were elected on a platform of free market economics, but rather to defend public services and benefits at all costs.
Thus Reeves has limited political room to always say no. It will be a lot easier to roll back the commitment to increase defence spending to 2.5 per cent of GDP, to empty jails rather than build new ones, and to increase taxation rather than save money through incentivising the 9.4 million economic inactive Britons aged 16-64 into work or reducing NHS bureaucracy.
A combination of low growth and sticky inflation (so-called ‘stagflation’) is never positive for gilts. The large number of mouths that Labour needs to feed will grow no smaller – and given that global bond yields often move in alignment, the prospect of a Donald Trump boom in the US makes it likely that the long-term cost of borrowing is going a lot higher in the coming years.
I have often felt that the price of money is the key to political power. It has always surprised me how few others think this. But it seems evident that when the rate of interest is low and stable, then an incumbent government enjoys a substantial political tailwind, and vice-versa.
The British political experience since the exit from the Gold Standard has been that major turning points in the fortunes of parties are marked by crises that sees interest rates rise rapidly. Labour may be about to experience a dose of this far quicker than it anticipates.