| You may have felt blessedly free to forget what a gilt is in the two years since Liz Truss and Kwasi Kwarteng’s disastrous mini-budget. It is with regret that I dust off Economics for Dummies (I don’t need it, you need it!!) to give you a reminder. Here’s an explainer from 2023. In short: gilts are UK government bonds, or promises to pay a lender a future sum – plus an annual interest payment, the yield – in return for their money today. They are bought and sold by traders after their initial issuance by the Treasury. When gilt prices on the market are high, that is a sign that investors think they present a sound investment. When they go down, that is because they fear that their money will be worth less when they get it back. Bond yields rise when gilt prices fall. So when investors have less confidence in the UK economy, yields go up. And in the last few weeks, that’s exactly what has been happening: yields on 10-year gilts (where the principal will be repaid in a decade’s time) have gone as high as 4.89%, their highest since 2008. Yields on 30-year gilts have been at their highest level since 1998. That means that government borrowing costs more. If that persists, it will be enough to wipe out the £9.9bn headroom that Reeves gave herself at the budget. What is the main cause of borrowing costs going up? The view of most credible analysts is that the events of recent weeks are primarily being driven by the prospect of Donald Trump’s presidency, and his threat to impose tariffs on imports to the US. “That is the overwhelming factor, in my view,” Richard said. “Tariffs could stoke inflation, because they get passed on to consumers buying goods made overseas. That could force the Federal Reserve to keep interest rates higher for longer.” High inflation is the bond trader’s nightmare, because it erodes the value of their loan. Those impacts come alongside Trump’s suggestion he will pursue large corporate tax cuts and increases to public spending – inflationary again – and the forced deportation of undocumented migrants, which could have a similar effect by pushing up wages. “The US is a supertanker in the global market,” Richard said. “It has an influence on bond prices and yields for everyone else.” Bond yields have gone up in the US, Germany, Japan, France and a host of comparable countries. Are there domestic factors as well? Borrowing costs have risen by more in the UK than in most countries. “The government is not blameless for the conditions in markets,” Richard said. He points to respected surveys showing a decrease in consumer and business confidence. “It might be exaggerated for the Conservatives to say that this is what happens when socialist governments tax and spend their way into trouble, but there is legitimate criticism for sure.” For one thing, that decline in confidence may partly be attributed to Labour’s negative messaging. Then there is the impact of the rise in employers’ national insurance contributions, a tax that Labour raised because it had ruled out any changes to the big revenue raisers of VAT, income tax and employees’ national insurance. “Companies are saying they are being forced to pass that on in the form of higher prices, which means an increase in inflation,” Richard said. “On the other hand, they may also cut staff, which would mean weaker wage growth, which would be disinflationary. There is a lot of uncertainty about that still.” Against a rough economic backdrop, growth figures have been disappointing since the budget, and the UK economy is in a long period of stagnation. There is a fear of “stagflation”, where poor growth is coupled with high inflation and is therefore difficult to take on with a rate cut. The increase in borrowing costs is also a reflection of traders’ fears that there will either be a recession or a big intervention from Rachel Reeves in response. What is the government doing? Ministers are treading a tightrope: on the one hand, insisting that nothing unusual is going on, and, as chief secretary to the Treasury Darren Jones told the House of Commons yesterday, “UK gilt markets continue to function in an orderly way”; and on the other hand, making that point in unusual statements that are themselves an indication that something out of the ordinary is afoot. That the Treasury issued two statements in two days to insist that Reeves maintains her grip on the economy is highly unusual, but the government was at pains to say that it was a response to a question from a journalist, rather than any formal intervention. By saying that they see no panicked behaviour among traders and reinforcing that the government will stick to its fiscal rules, ministers do appear to have calmed the markets somewhat, and the 10-year gilt yield fell back slightly yesterday. But the more significant action may lie ahead. “We’ll get inflation figures next week, and labour market data the week after that,” Richard said. “The Bank of England’s monetary policy committee will say what it’s doing on interest rates in February. And then the OBR will publish an updated economic and fiscal outlook report on 26 March.” If the economic picture remains disappointing but the MPC feels unable to go for a rate cut, Reeves will have to decide what to do to deal with the loss of her economic headroom that will result. As Richard notes in this piece, Reeves has “created something of a triple lock for herself”: a commitment not to break her fiscal rules on funding day to day spending through taxation, a promise not to increase taxes further and a promise not to return to austerity. If something has to give, it is most likely that she will bring spending down. Is there a chance this is all being overblown? Some of the doom-laden headlines of recent days – like the Daily Telegraph’s splash describing the Treasury comment that Reeves has an “iron grip” on the public finances as “stepping in to halt market mayhem” – may be a bit premature. “It is possible that the data coming out soon will be in the government’s favour,” Richard said. Some analysts think that bond traders are overreacting. “I think they have a point,” Richard said. “Many investors and market analysts at credible institutions still expect to see reductions in interest rates if growth is weak.” Even if that is likely, the danger is that traders’ reactions could become a self-fulfilling prophecy in the meantime. “There’s definitely that danger,” Richard said. “But it feels like we’re in the middle of a short-term flurry of activity in the bond market.” Importantly, the level of activity in the bond market is not comparable to the crisis after the Truss-Kwarteng mini-budget. “Yes, the gilt yield is higher, but you aren’t seeing the kind of extreme movements that you get in a real crisis. So the hope will be that once that froth has subsided, calmer heads might prevail.” If not, Reeves will have some brutal decisions to take. Doing so will probably head off an economic crisis. But for Labour, significant cuts to increases in public spending would probably constitute a political one, instead. “They have options available,” Richard said. “But there will be real consequences for the public, and politically, they are boxed in.” | 