As the Chancellor Rachel Reeves gets to work on her second Budget – to be delivered on 26 November – red lights flash everywhere. Gilt yields were up again as markets lost faith in her ability to balance the books. Reeves or Darren Jones – whoever is really calling the shots – will spend the next few weeks fixated on those yields. The price they land at when the Office for Budget Responsibility (OBR) settles their Budget forecast could make or break the government.
I understand that the initial plan was to have a Budget much earlier, but that the decision was taken to put it off for as long as possible in the hope that yields come down a bit in that time. We may even hear calming words from the Treasury today aimed at achieving just that.
It’s not all on Reeves though. The Chancellor does not shoulder all of the blame for the mess we’re in. The Bank of England has questions to answer too.
To fund the massive expansion of the state that happened during lockdown the Bank printed hundreds of billions of pounds. At the same time it tried to keep money cheap by holding interest rates near zero. The result was inflation that soared to 11 per cent. Even now inflation is back at near double the Bank’s 2 per cent target and is expected to peak at 4 per cent. Combine those two factors and you produce huge upwards pressure on the size and cost of the debt Reeves must now tax us to finance.
But in undoing that money printing the Bank is making things even worse for the Chancellor. That process – known as Quantitative Tightening (QT) – involves selling gilts held by the Bank back into the open market. So far they’ve been offloading longer-dated debt at a time when there’s less demand for it because of a change to the way pension funds are structured. These big institutional investors aren’t jumping to buy that longer-term debt and so the yield goes up further. When the Monetary Policy Committee meet later this month, Reeves will be praying they decide to at least slow the pace of those ‘long-end’ sales.
This longer-term debt shows just how concerned investors are at the prospect of systematically higher inflation and the fact there's ‘not even a seed of a conversation’ about reining in Britain’s unaffordable spending commitments’. They absolutely matter for the nations book but, luckily for the Chancellor, they'll have less of an immediate effect on the Budget. Most of the debt the Treasury Debt Management Office (DMO) now issues is shorter term. So while the 30-year yields reaching new heights is a screaming alarm about our economic future it doesn’t play too much into calculating the size of the black hole she will have to fill in two months' time.
That said, the ten-year gilt – which had stayed relatively flat this year – is now back at January levels. That alone could wipe out her slim £9.9 billion headroom, even before Starmer’s u-turns on welfare cuts and winter fuel cash bungs to pensioners are factored in. And, while the 30-year yield won't be directly factored into the OBR's calculations, they certainty point to where things are going 'across the curve'.
The problem for Reeves is that Torsten Bell may be able to squeeze just enough out of tax rises to plug the hole and get her very slim headroom back. But markets are clear: it's not enough. If yields keep rising – as inflation fears grow and the triple lock continues to live – such slim headroom will quickly evaporate again. What then?
She'd have to make cuts she doesn't want to make, she'd have to break manifesto pledges she's promised not to break but a much more radical budget restoring much larger headroom would be the smart thing to do. By giving herself more room to manoeuvre, she could not only reassure the markets but also arm herself – and Starmer – with the firepower needed for the next election. Will she be bold enough?
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