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The UK government was in a bind. Since the cost of borrowing has risen since the fall, the chances of fulfilling the main self-imposed fiscal rule – to borrow only for investments until the end of the decade – have decreased. The government responded to the failure with fierce rhetoric. Whether they come from Prime Minister Sir Keir Starmer, Rachel Reeves, his chancellor or their spokespeople, adjectives to describe the fiscal rules tend to mix between “armored” and “without negotiation“. Their attitude is always “absolutely committed“.
Sentiment has improved in UK government bond markets over the past week, but many have yet to be convinced. Ray Dalio, the billionaire founder of hedge fund firm Bridgewater Associates, is unimpressed, saying the gilts may be heading toward “death spiral“. Of course, this was overblown, but his comments reflect a wider concern in financial markets that there is a gap between tough fiscal rhetoric and the reality of UK budget policy – and it far predates the current Labor government.
It is therefore simply what is needed to ensure budgetary stability on which the rest of the UK economy can build. No more rhetoric. There are no more announcements of fiscal policy tightening either now or in the future. Instead, Reeves must implement the tax increases and spending plans outlined in October without compromising on when they should take effect in April.
These are huge. Coupled with large and disorderly increases in Employers’ National Insurance, income tax continues to rise in the form of frozen benefits and far from lavish increases in public expenditure. Together, the measures are set to decrease significant state borrowing. The overall deficit is projected to fall from 4.5 percent of GDP in 2024-2025. to 3.6 percent in 2025-26, while the current budget deficit, excluding capital investment, should halve from 2 percent of GDP to 0.9 percent in the same period.
This will be an exercise in showing, not telling. Debt cuts of this magnitude are reasonably rare for British governments – by the summer it will become clear whether Reeves and her policies are on the right track. Success would immediately show the difference between the UK’s fiscal policy and that of similar countries.
In recent years, American administrations have not shown the ability to achieve a deficit below 6 percent of GDP, and there is no improvement in sight. The European Commission expects that the French budget deficit will have exceeded 6 percent of GDP last year, with little prospect of a political agreement bringing much improvement. Germany’s fundamental public finances are strong, but its economy is weak. And debt levels in the UK, although high, are still far lower than those in Italy.
Bond markets often have minds of their own, but it would be hard to single out the UK for special punishment if it is the only decent-sized advanced country with the ability to legislate to impose fiscal consolidation and actually implement it. That’s what Reeves has to do. If growth suffers, the Bank of England would be well placed to ease monetary policy and neutralize fiscal tightening.
There are no guarantees in the business of convincing the financial markets that they have more to lose by betting against you. The UK government must also hope that consumers will start spending their recent real incomes and improve growth. It needs to be shown that any expansion will come with some recovery in productivity growth. And that increases in employers’ national insurance must not have a much more detrimental impact on jobs and prices than expected.
Nothing will be achieved by further talk of non-negotiable obligations with firm fiscal rules.
