How concerned should Rachel Reeves be that interest rates on government bonds have reached their highest levels in more than a quarter of a century?
More to the point, how worried should we be about this?
After all, the interest rate on 30-year government bonds (“Gilts,” as they are called) reached 5.37% today – the the highest level since 1998. The interest rate on the benchmark 10-year government bond also hits its highest level since 2008.
Higher government borrowing rates obviously mean that the cost of all the investment promised by Keir Starmer in the coming years will increase. And because these rates reflect long-term expectations for borrowing costs, what this means in practice is that everything else in this economy will become progressively more expensive.
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All of this has short and long term consequences. In the short term, this means that it will be more difficult for Ms. Reeves to respect the budgetary rules it has set for itself. Back to the budget, it has left itself a tiny margin (in tax terms) of £9.9 billion to not exceed its borrowing compared to its new rules.
According to Capital Economics, based on recent market developments, this margin may now have been reduced to around £1 billion.
And, given that this is before the Office for Budget Responsibility (OBR) has even decided to change its forecast, the question now becomes whether Ms Reeves will stick to its budget rules. Like my colleague Sam Coates reported this weekThe result is that the Treasury is set to cut its spending plans in the coming years – a depressing prospect given that the Chancellor has only just set them. But this will not be clear until the OBR’s updated forecasts are published in March.
However, fiscal rules and political embarrassments are one thing – the big picture is another. And that bigger picture is that the UK is being charged higher interest rates by international investors to compensate them for their concerns about our economic future – about rising interest rates. debt levels, on the threat of rising inflation and on fears of below-average growth in the years to come.
How does this compare to Liz Truss’ mini-budget?
But perhaps the bigger question is whether, given the higher long-term bond yields today (over 5.2%) compared to the highs they reached in October 2022, after the the famous mini-budget (4.8%), does this mean that the economy is in even more crisis than it was Liz Truss?
The short answer is no. This has nothing to do with the consequences of the post-mini-budget. Investors are worried about the UK’s debt levels – yes. They reassess our debt accordingly. There was even a moment, a few days after last autumn’s budget, when UK bond yields behaved erratically and worryingly, rising more than most of our peers.
But – and this is the crucial point – we have seen nothing like the levels of panic and worry in the markets that we saw after the mini-budget. But don’t believe me. Consider two data-driven metrics that are very useful in this case.
The first is to consider that in October 2022, interest rates on government bonds were not only rising. This is because the pound sterling was collapsing at the same time. This is a toxic cocktail, a sign that investors are simply pulling their money out of the country. This time around, the British pound is quite stable and much stronger than it was at the end of 2022, when it reached the lowest level (against a basket of currencies) in modern history.
Is this just a UK problem?
The second test is to ask a question: is the UK an exception? Do investors look at this country and treat it differently from other countries?
And here the answer is once again somewhat reassuring for Ms. Reeves. While it is certainly true that UK government bond yields have risen sharply in recent weeks, exactly the same is true for US government bond yields. Even German yields have risen in recent weeks – but not as much as in the US or UK.
In other words, movements in bond yields do not appear to be specific to the UK. They are part of a wider movement of assets globally, as investors look to the new future – with governments (including the UK and US under Donald Trump) willing to borrow more and spend more in the future. As I said, this is somewhat reassuring for Ms. Reeves, but I’m not sure it’s entirely reassuring for the rest of us.
One way to look at it is to measure the extent to which UK bond yields have diverged from those of their US and German cousins in recent months. And if there was a moment, a few days after Ms Reeves’ Halloween Budget, when UK bond yields were more outlier than they have been historically after budget events, in the weeks that followed , the United Kingdom has ceased to be an exception. Certainly, investors were asking for more, but given that the budget involved significant increases in spending and borrowing, this is hardly surprising.
Now compare that with what happened after the mini-budget, when UK bond yields diverged from those of their US and German counterparts more than after any other budget event in modern history – a terrifying rise that only ended after the resignation of Kwasi Kwarteng. It was only when Ms Truss resigned that they returned to what could be considered “normal” territory.
It is now difficult to compare different historical moments. The mini-budget comes at a tense time in financial markets, as the Bank of England prepares to reverse its quantitative easing program. Not every roller coaster can be attributed to Ms. Truss. Even so, comparing that period to today is like night and day.
Investors aren’t exactly thrilled with the UK’s economic outlook at the moment. They make it known via the financial markets. But they’re certainly not horrified like they were after the 2022 mini-budget.