Rachel Reeves confirmed on her trip to Washington DC that she will be changing the government’s self-imposed fiscal rules, allowing the Chancellor to borrow up to £50 billion more for infrastructure investment in Britain. The change – which will take into account the government’s assets – will further loosen what are already quite loose rules created by Rishi Sunak and Jeremy Hunt, which aimed to get debt falling as a percentage of GDP by the end of a five-year rolling period.
It’s no surprise then that international markets are a little nervous. While plans to change the fiscal rule have been floated for over a month now – giving investors time to prepare and adjust – the 10-year gilt yield still rose today to 4.26 per cent as the Chancellor confirmed her plans. While market movement calmed in the afternoon, the UK market stands in contrast to countries like the US and Germany, where the gap between yields expanded.
As I noted on Coffee House at the start of the month, Reeves is walking a tightrope rewriting these rules. Having ruled out any changes in the Labour manifesto – and indeed having previously referred to changes to ‘fiddling’ with figures to the detriment of the public finances – these changes are not just bound to make markets nervous, but to fixate international attention on the decisions Reeves makes around tax and spend in her first Budget next week.
With all eyes on her Budget, two major challenges lie ahead. The first will be to convince markets that her plans for borrowing will actually provide value. While Reeves remains committed to only using this additional money for capital investment, investors will still need to think these are worthwhile projects that will grow the UK economy in the medium term. The problem for Reeves, of course, is that the government doesn’t have the best track record for picking these projects, nor does it have a good history when it comes delivering these projects on time (case in point: HS2).
This won’t just be important from the investor perspective, but from the taxpayer’s perspective, too. With interest rates now dramatically higher than just a few years ago, what the government borrows – even if for a worthy cause – is going to cost the taxpayer much more to pay back. With debt-servicing payments already costing double the UK defence budget last year, those projects are going to need to be doing some serious economic lifting to pay for themselves down the road. Otherwise, it’s just an additional debt burden to be shouldered by further taxpayers.
This is Reeves’s other challenge. If Reeves wants to borrow more, she is going to have to convince the markets that she does not plan to rely on that borrowing to keep the public finances in check. This means tax rises and spending cuts – which are already expected in next week’s Budget. But this is unlikely to be a one-off austerity plan. Costs for the NHS and the triple lock on the state pension will just keep going up. To keep markets convinced that Labour will pay for what it wants to spend, more and more cash will be needed. Where Reeves finds it is only going to become more and more politically tricky.
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