The first female Chancellor, Rachel Reeves, fears following in the footsteps of the last female Prime Minister in her Autumn Budget statement.
The Gilt market sell-off in the wake of the Truss/Kwarteng fiscal event two years ago didn’t just cast a huge shadow over the Conservative Party; it reminded all politicians that financial markets can cost them their jobs.
And so we have seen Rachel Reeves painstakingly cleaving to the OBR and her fiscal rules ever since the Labour Party won the election.
This comes with its own ramifications. By ensuring the OBR would have the full 10 weeks they require for the forecast rounds ahead of the Budget, she couldn’t hold the big event any sooner, not least with party conference season hoovering up the calendar.
Liz Truss jettisoned the budget watchdog altogether, and look at how that ended. But a vacuum has been created while waiting for the OBR to spit out its calculations. Gilt traders have had to parse minimal output from the Chancellor for clues. And it’s making them nervous.
The markets are getting nervous
The spread of UK 10-year yields versus a G7-ex-UK average has risen to its highest in over a year, driven by concerns over Reeves’ fiscal rules. Although she has embraced those she inherited from the Conservative government, she is tweaking them so that she can borrow more to invest more.
We won’t know the full details until Wednesday, but she is expected to adjust the measurement of the government’s debt and give herself up to five years to balance the current budget.
This will mean more government borrowing, channelled towards productive investment that should also lead to growth. Will the Gilt markets buy this argument?
It depends.
Partly it will be a question of numbers. Bond investors all over the world have been asked to digest more and more issuance since the pandemic, with governments forced to borrow to offset economic calamity.
The Debt Management Office has planned Gilt sales for the current financial year of £278bn. Another £20bn per year might be digestible in the market, whereas £60bn might not.
But it is not just a numbers game.
Spending on debt is growing
As the debt pile grows and interest rates ratchet higher, countries must spend more money on servicing the debt. Hence the obsession with growth – anyone with an overdraft or credit card knows they need more money to come in each month to keep paying the bills. At some stage, the bank will check if you’re credibly able to keep going with the debt you’ve got.
For Rachel Reeves, this means convincing the market that the extra borrowing must be put to good use. As the IFS chided in their Green Budget, ‘if the government wants to relax its debt rule to allow for more borrowing for investment, it is not enough to justify this on the grounds that ‘investment is good’. It also needs to explain why we should be borrowing to pay for it… it should make the case for this explicitly, rather than hiding behind a ‘technical’ change’.
There is also the gnawing fear that the extra borrowing won’t be used for investment at all but rather for funding day-to-day spending.
In March, when delivering the Mais Lecture, Rachel Reeves said that ‘the current budget must move into balance’ but she didn’t say by when.
When pressed by the FT more recently on the timetable, she said ‘five years is obviously the maximum’. This phrase alone served to take Gilt yields a few basis points higher as markets worried that her commitment to prudence wasn’t quite as immediate as they had thought.
This is not the impression she wanted to give. In her Labour Party conference speech she said ‘We were elected because, for the first time in almost two decades, people looked at us – looked at me – and decided that Labour could be trusted with their money’. She really is putting her own neck on the line. Her first act as Chancellor came with a political cost. She settled public sector pay deals but chose to pay for (at least part of) this by restricting the Winter Fuel Allowance for pensioners. Her own party voted against this latter decision at their conference.
But she had to find something. Remember the Truss-shaped ghost of fiscal events past? Reeves had to take early action for the sake of the OBR.
Higher growth forecast
Removing the risk of industrial action by settling pay deals should enable the OBR to forecast higher economic growth ahead.
Restricting the winter fuel payment reduced the deficit here and now, with the eligibility for the winter fuel payment factored into the public sector net debt calculation in September. All of this creates little extra inches of fiscal headroom.
It also demonstrates to the markets that she isn’t afraid of tough decisions. In effect, she is choosing the markets over her party – the exact opposite of Liz Truss. This is sensible. Reeves has the advantage of a large majority and five years until the next election. Take the tough political decisions now, gain credibility, and the market will allow her to invest for growth.
As a self-confessed ‘girlie swot’, Reeves will have done her homework. The spreadsheet will add up. She now needs to sell the market on her ability to keep up the good work whilst convincing her party, and the electorate, that growth is coming.